Rev. Rul. 68-486

Advice has been requested concerning the Federal income tax treatment to be accorded to certain payments received from the United States Civil Service Retirement and Disability Fund by a retired employee of the United States Government.

An employee retired from the service of the United States Government after having met the age and length-of-service requirements necessary to entitle him to receive immediate retirement benefits from the United States Civil Service Retirement and Disability Fund upon filing a valid claim. He filed a claim for benefits five years later but prior to the time he reached the mandatory retirement age. He then became eligible to receive a lump-sum payment representing accrued monthly installments covering the period from the date of his retirement to the date the claim was filed. Thereafter, he was eligible to receive regular monthly annuity payments for life. That part of the lump-sum payment representing the first three years of accrued monthly installments exceeded his total contributions to the United States Civil Service Retirement and Disability Fund.

A person receiving an annuity from the Fund is not barred from reemployment by the United States Government by reason of his retired status; however, an annuitant who is so reemployed serves at the will of the appointing authority. 5 U.S.C. 3323(b) (Supplement II). Thus, a reemployed annuitant has none of the job retention rights he would have had if he had not become an annuitant before his reemployment.

The United States Civil Service Retirement and Disability Fund is a qualified trust under section 401(a) of the Internal Revenue Code of 1954 and exempt from Federal income tax under section 501(a) of the Code. See Revenue Ruling 58-472, C.B. 1958, 30, at 32.

Section 402(a)(1) of the Code provides that amounts actually distributed or made available to any distributee by any employees' trust described in section 401(a) of the Code and exempt from tax under section 501(a) of the Code are taxable to the distributee in the year in which so distributed or made available, under the provisions of section 72 of the Code.

Section 1.72-13(a)(1) of the Income Tax Regulations provides that under section 72(d) of the Code, all amounts received as an annuity by an employee under a contract during a taxable year to which the Code applies, shall be excluded from the employee's gross income until the total of the amounts excluded under that section of the Code, plus all amounts excluded under prior income tax laws, equals or exceeds the consideration contributed by the employee. The excess, if any, and all amounts received by any recipient thereafter (whether or not received as an annuity), shall be fully included in gross income. This rule is applicable only in the event that: (1) at least part of the consideration for the contract is contributed by the employer, and (2) the aggregate amount receivable as an annuity under such contract by the employee within the three year period beginning on the date on which an amount is first received as an annuity, equals or exceeds the total consideration contributed by the employee as of such date as reduced by all amounts previously received and excludable from the recipient's gross income under the applicable income tax law.

Revenue Ruling 55-423, C.B. 1955-1, 41, holds that a participant's interest under an exempt employees' trust is not made available to him within the purview of section 401(a)(1) of the Code if there are substantial conditions or restrictions on his rights of withdrawal. The principle stated in Revenue Ruling 55-423 also has been applied, by Revenue Ruling 60-292, C.B. 1960-2, 153, to a case in which a separated employee would lose his prior service credits under the plan if he withdrew his account and, within five years, re-entered the employer's service. Revenue Ruling 60-292 holds that such an employee's loss of prior service credits upon withdrawal of his account balance constitutes a substantial condition on his right of withdrawal. Therefore, the amount standing to his credit under the trust was not made available to him upon his separation from the service.

In the instant case the retired employee could have filed a claim for benefits upon his retirement, in which case he would have become an annuitant with no job retention rights in the event of his reemployment. This loss of job retention rights in the event of reemployment constitutes a substantial condition attached to the exercise of his right to receive annuity payments.

In view of the foregoing, that part of the lump-sum payment representing the monthly benefits which accrued to the retired employee between the date of his retirement and the time he filed a valid claim for benefits from the United States Civil Service Retirement and Disability Fund, that exceeds his contribution to the fund, is includible in his gross income in the taxable year received. If the retired employee qualifies as an eligible individual, the portion of the lump-sum payment that is includible in gross income will become part of any other averagable income he may have under section 1301 of the Code.

Furthermore, amounts received as monthly installment benefits after receipt of the lump-sum payment, are includible in the retired employee's gross income in the year received and taxable in full under the provisions of section 72(d) of the Code relating to amounts received as an annuity where the employee's contributions are recoverable in three years.