Rev. Rul. 73-124

Advice has been requested whether, under the circumstances described below, the amount received by an employee under the surrender of an individual annuity contract is includible in his gross income.

An organization that is exempt from Federal income tax under section 501(c)(3) of the Internal Revenue Code of 1954 entered into an agreement with one of its employees pursuant to which the organization was to purchase a noncontributory individual annuity contract under an agreement that met the requirements of section 403(b) of the Code. The contract also met the requirements of section 401(g) of the Code, which states that the term "annuity" does not include a contract which is transferable if any person other than the trustee of a trust described in section 401(a) is the owner. In a subsequent year, the employee entered into a binding agreement with his employer whereby the employer discontinued making contributions under the annuity contract on behalf of the employee and, at the same time, began making like contributions under a new individual annuity contract with a different insurer. In order to transfer his interest in the first contract to the new annuity contract, the employee further agreed to pay to the employer an amount equal to any amount received under the first contract and the employer, in turn, agreed to apply such amount to provide benefits for the employee under the new contract. In a single integrated transaction, the employee then surrendered his entire interest in the first contract to the insurer in exchange for a check which he immediately endorsed and paid over to the employer for use in providing benefits under the second contract.

Section 403(b) of the Code provides that the employee shall include in his gross income the amounts received under an annuity contract purchased under an arrangement described therein in the taxable year received, as provided in section 72 (relating to annuities).

Section 72(e) of the Code states the general rule that, if no other provision of chapter 1, subtitle A of the Code (relating to income tax) applies, any amount received under an annuity contract that is not received as an annuity (including an amount received upon the surrender of the contract) is to be included in gross income to the extent that it exceeds the aggregate premiums or other consideration paid therefor.

Section 1035(a)(3) of the Code provides that no gain or loss shall be recognized on the exchange of an annuity contract for an annuity contract.

Section 1.1035-1(c) of the Income Tax Regulations provides that the exchange, without recognition of gain or loss, of an annuity contract for another annuity contract under section 1035(a)(3) is limited to cases where the same person or persons are the obligee or obligees under the contract received in exchange as under the original contract. There is no requirement in that regulation that the issuer of the contract received in exchange be the same as the issuer of the original contract.

Also see Revenue Ruling 72-358, 1972-2 C.B. 473, which holds that no gain or loss is recognized on the exchange, prior to its maturity, of a life insurance contract with one insurance company for a variable annuity contract with another insurance company.

In this case, the same employee is the obligee under the contract received as under the contract surrendered. The fact the the employee must first surrender the original annuity contract to an insurer because of the restrictions required by section 401(g) of the Code does not prevent the total transaction from being an exchange within the meaning of section 1035 of the Code provided the proceeds received upon surrender are applied immediately to the purchase of a second annuity contract for the same employee.

Accordingly, under the circumstances described above, it is held that the amount received by the employee upon the surrender of the annuity contract is not includible in his gross income, under section 72(e) of the Code, at the time of such surrender.