Rev. Rul. 74-398

Advice has been requested (1) whether the amount of net unrealized appreciation in employer securities received by a beneficiary as a part of a "total distributions payable" from a qualified employees' pension trust by reason of the death of an employee is includible in the basis of such securities in the hands of the beneficiary where the employee's death benefit exclusion is applicable, and (2) whether the earnings realized on the employee's contributions to the trust, which are included in a total distributions payable, may qualify for the employee's death benefit exclusion.

Under the terms of a qualified pension plan of the money-purchase type, each employee contributes, through payroll deductions, six percent of his total pay. The company matches the employee's contribution with a contribution of 50 percent of the amount the employee contributes. Employees may elect to have their contributions invested in the common stock of the company. All of the contributions made by the company are invested in its own common stock. Upon the death of an employee-participant, his beneficiary is entitled to receive the entire amount in the employee's account, including the amounts attributable to both the employee's contributions and company contributions.

In this case an employee's service terminated by reason of his death, and his beneficiary received the balance standing to his credit, within one taxable year of the beneficiary. The distribution consisted of $2,500 in cash and shares of company stock which cost the trustee $4,200 and which had a fair market value at the date of distribution of $8,000. The deceased employee had contributed $4,000 under the terms of the plan.

Section 402(a)(3)(C) of the Internal Revenue Code of 1954 defines the term "total distributions payable" as the balance to the credit of an employee which becomes payable to a distributee on account of the employee's death or other separation from the service, or on account of his death after separation from the service.

Subject to the limitations of section 402(a)(5) of the Code, section 402(a)(2) provides that if the total distributions payable with respect to any employee are paid to the distributee within one taxable year of the distributee the amount of such distribution, to the extent exceeding the amounts contributed by the employee, shall be considered a gain from the sale or exchange of a capital asset held for more than six months. Section 1.402(a)-1(a)(6)(i) of the Income Tax Regulations provides that the net amount contributed by the employee is the amount actually contributed by the employee plus any amount considered to be contributed by the employee under the rules of sections 72(f) and 101(b) of the Code.

Section 402(a)(2) of the Code also provides that, where a "total distributions payable" includes securities of the employer corporation, there shall be excluded from the excess of the distribution over the amounts contributed by the employee the net unrealized appreciation attributable to that part of the total distributions which consists of the securities of the employer corporation so distributed. The amount of such net unrealized appreciation and the resulting adjustments to the basis of the securities of the employer corporation so distributed are determined in accordance with section 1.402(a)-1(b) of the regulations. This section provides that if a qualified employees' trust makes a total distributions payable to a distributee, and such distribution includes securities of the employer corporation, the entire amount of net unrealized appreciation in such securities shall be excluded from the distributee's income in the year of such distribution. The amount of net unrealized appreciation which is excludable under this rule shall not be included in the basis of the securities in the hands of the distributee at the time of distribution for purposes of determining gain or loss on their subsequent disposition. See section 1.402(a)-1(b)(1)(i) of the regulations.

Section 101(b)(1) of the Code provides in effect that gross income does not include amounts received (whether in a single sum or otherwise) by the beneficiary or the estate of an employee, if such amounts are paid by or on behalf of an employer and are paid by reason of the death of the employee. Under section 101(b)(2) of the Code the aggregate amount excludable with respect to the death of an employee shall not exceed $5,000.

The operations of sections 402(a) and 101(b) of the Code are mutually exclusive. Therefore, a determination under section 402(a)(2) of the Code with respect to net unrealized appreciation in employer securities does not affect or limit the making of whatever determination is required under the provisions of section 101(b). Thus, in a given factual situation, to the extent it is determined that an amount is excludable under section 101(b), such amount is to be treated as additional consideration paid by the employee for the contract for the taxable year in which the distribution is made available or actually received. See section 402(a)(2) of the Code, which refers to section 72(f) for a determination of amounts contributed by the employee, and section 1.72-8(b) of the regulations, which includes in the amount of consideration paid or deemed paid by the employee amounts excludable from gross income as a death benefit under section 101(b) of the Code.

Accordingly, with respect to question (1) above, it is held that for the purpose of determining a gain under pertinent provisions of the law on the subsequent disposition of employer securities received from the trust by a beneficiary as a "total distributions payable," the net unrealized appreciation to the extent, if any, previously excluded under section 402(a)(2) of the Code is not included in the basis of such securities in the hands of the beneficiary. However, for the purpose of section 402(a)(2) to the extent an amount was otherwise determined excludable as a death benefit under the provisions of section 101(b) such amount is deemed to be additional consideration paid by the employee for the contract. Therefore, it is includible in the basis of the securities received by the beneficiary to the extent allocable to the employer securities.

In view of the foregoing, the basis of the securities in the hands of the beneficiary in the instant case to be taken into account upon subsequent disposition is computed as indicated below under applicable provisions of the Code and regulations:

      1. Death benefit exclusion under section 101(b) of the Code.

      (a) Fair market value of company stock              $8,000

      (a) Value of the total distribution (item 1(a)

      (a) Amount contributed or deemed contributed by