Rev. Rul. 61-10

Advice has been requested concerning the tax consequences of a lump-sum distribution of the total amount standing to the credit of a participant in a qualified employees' trusted pension plan where the distribution is made to such employee upon his separation from service at a time when the plan has been in existence for less than ten years, and adequate provision is made for repayment of any part of the distribution which is restricted under certain plan provisions (1) if the plan is terminated within the first ten years after establishment or (2) if, at any time during this period, the full current costs of the plan are not met.

A corporation had established an employees' trusteed pension plan. The principles of Mimeograph 5717, C.B. 1944, 321, were incorporated in the plan. Mimeograph 5717 holds, in effect, that pension plans, in order to be considered acceptable within the purview of section 401(a)(4) of the Internal Revenue Code of 1954, generally must contain provisions so that during the first ten years after establishment of the plan the employer contributions which may be used for benefits of any of the 25 highest paid employees will be limited as specified in the Mimeograph.

In the instant case, the plan qualifies under section 401(a) of the Code and the trust forming a part thereof is exempt from tax under section 501(a) of the Code.

An employee of the corporation, who was one of the 25 highest paid employee-participants in the plan and trust, terminated his employment with the corporation. At this point, the plan had been in existence less than ten years. Under the terms of the plan, the employee was entitled to a lump-sum distribution of the total amount standing to his credit in the trust fund. Prior to his separation from the service of the corporation, the employee entered into an agreement with the trustee to the effect that in the event (a) the plan terminates within the first ten years of its establishment, or (b) a default occurs in the payment of the full current costs of the plan for any year ending within the first ten years after establishment of the plan, and (c) such lump sum has been distributed, the distributee (or, in the case of his death, his estate) will repay to the trustee a sum equal to the actuarial value of the amounts by which his monthly retirement income benefits under the plan would have been decreased during his then remaining lifetime pursuant to the provisions of the plan which give effect to the principles of Mimeograph 5717. The proviso further requires that the obligation under the agreement to repay be adequately secured.

In order to guarantee the repayment of any amount required to be repaid under the agreement, the distributee agreed that promptly after the distribution of the lump-sum payment he would deposit with an acceptable depositary property having a fair market value equal to 125 percent of the amount which would be repayable if the plan had terminated on the date of distribution of such lump-sum. He further agreed that, if the market value of the property held by the depositary falls below 110 percent of the amount which would then be repayable if the plan were then to terminate, he would deposit additional property necessary to bring the value of the property held by the depositary up to 125 percent of such amount.

The distributee has the right to receive any income from the property placed on deposit subject to the obligations to maintain the value of the property as above described.

The depositary may not redeliver any property held under the agreement to the distributee (or his estate) except upon receipt of a certification of the trustee that the distributee (or his estate) is no longer obligated to repay any amount under the agreement.

It is apparent that adequate precautions have been taken to secure the repayment to the trustee in the event such repayment becomes necessary should the event requiring repayment occur.

Section 402(a)(1) of the Code provides that, except as provided in paragraph (2) of section 402(a), amounts distributed or made available by an employees' trust of the type described in section 401(a), which is exempt under section 501(a), shall be taxable in the year in which distributed or made available, in accordance with section 72, relating to annuities (except that section 72(e)(3) shall not apply).

Section 402(a)(2) provides that if the total distributions payable from such trust are paid 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 his separation from the service, the amount of such distribution, to the extent exceeding the employee's contributions, is considered a long-term capital gain.

Under the facts in the instant case, it is held that, upon separation from service of the employee, the lump-sum distribution of the total amount standing to his credit in the trust will be entitled to the capital gains treatment provided by section 402(a)(2) of the Code.

Mimeograph 5717 is hereby modified to permit a lump-sum distribution, in an amount in excess of that otherwise permitted thereunder, provided there is adequate provision for repayment of any part of the distribution representing the restricted portion in the event of a termination of the plan or a default in payment of the full current costs of the plan within the first ten years after its establishment.