Rev. Rul. 72-305

Advice has been requested concerning the proper Federal income tax treatment, under the circumstances described below, where, upon separation from service, a participant received a lump-sum cash distribution of his entire interest in an exempt employees' trust in an amount less than the aggregate of his contributions to the trust.

An employer established a contributory profit-sharing plan that meets the requirements of section 401(a) of the Internal Revenue Code of 1954 and a related trust that is exempt from income tax under section 501(a).

As a result of investment losses by the trust, an employee-participant, upon separation from service, received a cash distribution of his entire interest under the trust in an amount less than the aggregate of his contributions under the plan.

Section 402(a)(1) of the Code provides that the amounts actually distributed or made available to any distributee by an exempt employees' trust shall be taxable to him in the year in which such amounts are actually distributed or made available under section 72 of the Code (relating to annuities).

Subject to certain limitations contained in section 402(a)(5) of the Code, section 402(a)(2) provides that, in the case of an exempt employees' trust, if the total distributions payable 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 service, the amount of such distribution, to the extent it exceeds the amount contributed by the employee (determined by applying section 72(f) of the Code), shall be considered a gain from the sale or exchange of a capital asset held for more than six months.

Section 165(c)(2) of the Code provides for the deduction of any loss sustained by an individual during the taxable year, not compensated by insurance or otherwise, where such loss is incurred in any transaction entered into for profit, though not connected with a trade or business. The loss must be evidenced by closed and completed transactions, fixed by identifiable events, and actually sustained during the taxable year. Section 1.165-1(b) of the Income Tax Regulations.

Section 72(e)(1)(B) of the Code provides that if an amount is received under an annuity, endowment, or life insurance contract, and if such amount is not received as an annuity, then such amount shall be includible in gross income, but only to the extent that it (when added to the amounts previously received under the contract which were excludable from gross income) exceeds the aggregate premiums or other consideration paid.

Sections 72 and 402 of the Code are concerned only with the extent to which amounts received under an annuity, endowment, or life insurance contract or as a distribution from an employees' trust are includible in gross income. Neither section deals with situations in which the employee's own contributions to the trust exceed the value of his entire interest in the trust at the time of distribution. However, an employee's participation in a profit-sharing plan is a transaction entered into for profit, and the lump-sum cash distribution of an employee's entire interest under the trust in the case was a closed and completed transaction, within the meaning of section 1.165-1(b) of the regulations.

In the present situation there is no gain, so that the taxability provisions of sections 402 and 72 of the Code are not applicable. Furthermore, since the cash distributions result in a loss to the distributee in the year of distribution, it is of the character referred to in section 165(c)(2) of the Code.

Accordingly, it is held that the difference between the amount of the aggregate employee contributions and the lump-sum cash distribution is deductible as an ordinary loss, under section 165 of the Code, in the year the employee received the distribution, but only if the employee itemizes his deductions for that year.