Rev. Rul. 58-99

Advice has been requested relative to the taxability of a distribution from a trust forming part of the qualified employees' pension plan established by a parent corporation and its subsidiary when the subsidiary corporation is separated from and severs all connections with the parent corporation and distribution is made to the employees of the subsidiary of the total amounts standing to their credit in the trust.

The employees of the S corporation, a subsidiary of the P corporation, were participants in the trust forming a part of the employees' noncontributory pension plan established by the two corporations. The plan and trust have been held to meet the requirements of section 401(a) of the Internal Revenue Code of 1954 and the trust to be exempt under section 501(a) of the Code. Control of the S corporation was obtained by other interests under which it continued to operate as a separate taxable entity. The plan was at that time discontinued as to the employees of the S corporation. The total amount standing to the credit of the S corporation employees in the trust established as a part of the pension plan was distributed in cash in a lump-sum to those employees.

Distributions from a qualified employee's trust are taxable in accordance with section 402(a) of the Code. Paragraph (1) thereof provides, in part, that amounts actually distributed or made available shall be taxable in the year in which distributed or made available, under section 72 of the Code except that section 72(e)(3) shall not apply. Section 402(a)(2) of the Code provide provides that if the total distributions payable under a qualified trust, with respect to any employee, are paid to the distributee within one taxable year of the distributee on account of the employee's death or other separation from the service, or on account of the employee's death after separation from the service, the amount of such distribution, to the extent exceeding the amounts contributed by the employee, shall be considered a gain from the sale or exchange of a capital asset held for more than six months.

In the cases of Edward Joseph Glinski, Jr. v. Commissioner , 17 T.C. 562, the Tax Court of the United States, in sustaining the Commissioner's findings that a distribution under a qualified trust was taxable as ordinary income and not as long-term capital gain stated, in part, `Total distributions `on account of the employee's separation from the service' means that the distributions were made on account of the employee's separation from the service of his employer.' Also, in Estate of Frank B. Fry v. Commissioner , 19 T.C. 461, affirmed, 205 Fed.(2d) 517, it was held that where an employee received the distributions payable to him by reason of his participation in an employees' trust but the employee continued to render services and receive his regular salary, the distribution was taxable as ordinary income. Here the Court stated, in part, that `In order to obtain the benefits permitted under section 165(b) of the Internal Revenue Code (corresponding to section 402(a)(2) of the 1954 Code), the decedent must have been retired or severed his connection with his employer. * * *' (Parenthesis supplied.) See Rev. Rul. 56-214, C.B. 1956-1, 196.

From the foregoing it is seen that employees of the S corporation prior to its separation from the parent, P corporation, continued as employees of S corporation subsequent to the separation of the two companies. Thus, the distributions from the instant pension trust cannot be said to have been made `on account of the employee's separation from the service' of the employer, the S corporation.

Accordingly, it is held that where the employees of a subsidiary corporation were participants in the qualified employees' pension plan and trust established by the parent corporation and such subsidiary, and the subsidiary is separated from the parent corporation and continues as a separate taxable entity, a distribution from the employees' trust of the total amount standing to the credit of the employees of the subsidiary corporation cannot be considered as having been made on account of the employee's separation from the service within the meaning of section 402(a)(2) of the Code and is, therefore, taxable under the provisions of section 72 of the Code.