Rev. Rul. 59-254

Advice has been requested whether annuities received by survivors of retired members of the uniformed services under the provisions of the Uniformed Services Contingency Option Act of 1953, 37 U.S.C. 372, as amended, repealed by Act of August 10, 1956, 70A Stat. 641, and now covered by Title 10, United States Code, sections 1431-1433, are to be treated as employees' annuities under section 72(d) of the Internal Revenue Code of 1954, or whether the exclusion ratio under section 72(b) will apply; and whether the value of such annuity is includible in the gross estate of a decedent for estate tax purposes.

Under the provisions of the Uniformed Services Contingency Option Act, supra , as amended, an active or retired member of the uniformed formed services, entitled to receive `retired pay' as a result of his service in the uniformed services, may elect to receive a reduced amount in order to provide one or more annuities payable after his death to his widow, child, or children. He is not required to provide annuities for his dependents. Such action is voluntary on his part. However, if he wishes to participate in the plan he must elect to do so within a specified time or be barred from the annuity program. The Act provides for the modification or revocation of an election and, also, for its further operation in various eventualities.

In the House of Representatives Report No. 496, 83rd Congress, which accompanied H.R. No. 5304 (Uniformed Services Contingency Option Act), it is stated that:

At the same time the bill provides that the individual has wide choice as to how he may divide his retired pay. He may elect to protect his widow. He may elect to protect his children. He may elect to protect his family, meaning his widow and children, in 1 of 2 ways. Under the bill this wide latitude of choice is his, but he will pay the full cost of his choice no matter which one he makes.

In Senate Report No. 672, which also accompanied H.R. 5304, it is stated that:

This measure should involve no additional costs to the Government other than administrative costs. The deductions to be made in the retired pay of retired members electing to provide an annuity for their dependents would be determined by the actuarial equivalent method, which means that the deductions in pay during the retired member's lifetime would on the average be sufficient to pay for the benefits accruing to his dependents after his death, thus insuring no increased cost to the Government in retirement benefits.

Section 72(b) of the Code provides for the exclusion from gross income of that part of any amount received as an annuity which bears the same ratio to such amount as the investment in the contract bears to the expected return under the contract, except in the case of employees' annuities to which section 72(d) applies.

Section 72(d)(1) of the Code relative to employees' annuities reads as follows:

Employee's Contributions Recoverable in 3 years.-Where-

(A) part of the consideration for an annuity, endowment, or life insurance contract is contributed by the employer, and

(B) during the 3 year period beginning on the date (whether or not before January 1, 1954) on which an amount is first received under the contract as an annuity, the aggregate amount receivable by the employee under the terms of the contract is equal to or greater than the consideration for the contract contributed by the employee, then all amounts received as an annuity under the contract shall be excluded from gross income until there has been so excluded (under this paragraph and prior income tax laws) an amount equal to the consideration for the contract contributed by the employee. Thereafter all amounts so received under the contract shall be included in gross income.

In order for section 72(d) of the Code to be applicable, two conditions must be met: (1) part of the consideration for the annuity must be contributed by the employer, and (2) the aggregate amount receivable as an annuity under the contract within the three-year period beginning on the date on which an amount is first received as an annuity must be equal to or greater than the consideration for the contract contributed by the employee. If these two conditions are met, all amounts received as an annuity under the contract shall be excluded from gross income until the total of the amount equals or exceeds the consideration contributed by the employee. The excess, if any, and all amounts received by any recipient thereafter must be fully included in gross income.

Revenue Ruling 54-144, C.B. 1954-1, 15, holds that the annuities paid beneficiaries under the Uniformed Services Contingency Option Act may not be excluded under section 22(b)(1)(B) of the 1939 Code, since such annuity payments were made in consideration of the annuity premiums paid by reired members rather than by the employer in consideration of past services.

Accordingly, it is held that annuity payments received by the widow, child, or children of a retired member of the uniformed services under the Uniformed Services Contingency Option Act of 1953, supra , the entire cost of which is borne by the serviceman, are taxable to the extent and in the manner provided in section 72(a) and (b) of the 1954 Code, since the requirement of section 72(d)(1)(A) that part of the consideration for the annuity be contributed by the employer has not been met.

Section 2039(a) of the 1954 Code provides for the inclusion in the decedent's gross estate of the value of an annuity or other payment receivable by any beneficiary by reason of surviving the decedent under any form of contract or agreement (other than insurance on the decedent's life) if, under such contract or agreement, an annuity or other payment was payable to the decedent, or the decedent possessed the right to received such annuity or other payment for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death.

Section 2039(b) provides that subsection (a) shall apply to only such part of the value of the annuity or other payment receivable under such contract or agreement as is proportionate to that part of the purchase price therefor contributed by the decedent.

Section 2039(c), which is applicable to decedents dying after December 31, 1953, provides that where the decedent contributes to a plan which qualifies under section 401(a), the amount to be included in his gross estate for estate tax purposes shall be only that proportion of the value of the annuity or other payment receivable by the surviving beneficiary which the value of the payments or contributions made by the decedent under the contract or agreement bears to the total payments or contributions made.

Since, under the Uniformed Services Contingency Option Act of 1953, supra , the retired member of the uniformed services bears the entire cost of the annuity which he elects upon retirement to have paid to his widow or other survivors, and the conditions and circumstances under which the annuities are paid do not meet the requirements of section 401(a) of the Code, it is held that the entire value of the annuity payable to the widow, child, or children of the retired member of the uniformed services under such Act is includible in the gross estate of such deceased member under the provisions of section 2039 of the Code.