Rev. Rul. 79-301

ISSUE

Is the employer's contribution to a retirement fund a purchase of a retirement annuity contract within the meaning of section 2039(c)(3) of the Internal Revenue Code under the circumstances described below?

FACTS

The decedent, D, was a professor at the University of State X. Pursuant to the terms of D's employment, the university made contributions to the State X retirement system on D's behalf. The custodian of the retirement system was thereby obligated to provide an annuity to D upon D's retirement. D did not make any contributions to the retirement system.

The State X retirement system is a general fund for employees of the state, counties and schools within the state. The State X retirement system is not a qualified plan under section 401(a) of the Code.

The university is exempt from tax under section 501(a) of the Code as an organization that is operated exclusively for educational purposes in accordance with section 501(c)(3). Further, as an educational institution that receives a substantial part of its support from State X, the university is an organization referred to in section 170(b)(1)(A)(ii) and (vi).

Upon D's retirement in 1973, D received a retirement annuity from the State X retirement system. At D's death in 1976, D's spouse was entitled to receive a residual retirement annuity valued at 40x dollars.

LAW AND ANALYSIS

Section 2039(a) and (b) of the Code provides that a decedent's gross estate includes the value of an annuity or other payment receivable by any beneficiary by reason of surviving the decedent, under any contract or agreement (other than insurance on the decedent's life), to the extent that the value of the annuity or other payment is attributable to contributions made by the decedent or the decedent's employer.

Section 2039(c)(3) of the Code provides an exclusion from the gross estate for the value of an annuity or other benefit receivable by a beneficiary under a retirement annuity contract purchased for an employee by an employer that is an organization referred to in section 170(b)(1)(A)(ii) or (vi) and that is exempt from tax under section 501(a). No exclusion is allowed for the portion of the annuity attributable to contributions made by the decedent. Contributions made by the decedent's employer toward the purchase of the retirement annuity contract shall not, to the extent excludable from the decedent's gross income under section 403(b), be considered to be contributed by the decedent. Section 2039(c), as amended by the Tax Reform Act of 1976 [Pub. L. 94-455, 1976-3 C.B. (Vol. 1) 1], effective for decedents dying after December 31, 1976, limits the exclusion to an annuity or payments other than a lump sum distribution described in section 402(e)(4).

For the beneficiary's annuity to be excluded under section 2039(c)(3) of the Code, the benefit must be receivable under a retirement annuity contract purchased by the organization. Both Rev. Rul. 68-487, 1968-2 C.B. 187, and Rev. Rul. 68-488, 1968-2 C.B. 188, amplify what is the purchase of a retirement annuity contract for purposes of the income tax exclusion allowance provided for in section 403(b).

In Rev. Rul. 68-487, an organization contributed to individual investment accounts for each of its employees. An employee was not entitled to annuity benefits unless the employee directed the custodian of the accounts to apply funds from the employee's account to a group annuity contract. The arrangement was not the purchase of annuity contracts by the organization since the custodian of the fund was not obligated to provide annuity benefits.

In Rev. Rul. 68-488, an organization's contributions to an investment arrangement were the purchases of retirement annuities because the custodian of the fund was obligated, at the inception of the arrangement, to provide the organization's employees with periodic retirement benefits, determined by recognized mortality tables. See also Rev. Rul. 67-387, 1967-2 C.B. 153.

Thus, for purposes of section 2039(c)(3) of the Code, payments to a retirement fund by an organization will be regarded as the purchase of a retirement annuity contract for the organization's employee if the payments are made pursuant to a contractual arrangement between the organization and the custodian of the fund whereby the custodian of the fund is obligated to provide an annuity to the employee.

D and D's survivor became entitled to the annuity benefits by reason of an enforceable agreement between D and the university. Therefore, the value of the annuity receivable by D's spouse comes within the purview of section 2039(a) and (b) of the Code.

However, since the university's contributions were made pursuant to a contractual arrangement with the custodian of the retirement system that required the payment of an annuity to D, the transaction was the purchase of a retirement annuity contract by the university. Therefore, the exclusion provision of section 2039(c)(3) of the Code is applicable to the spouse's annuity because the university, an organization referred to in section 170(b)(1)(A)(ii) and (vi) that is exempt from tax under section 501(a), purchased the annuity for D under a retirement annuity contract.

HOLDING

The contributions of the university to the retirement system were the purchases of retirement annuity contracts for purposes of section 2039(c)(3) of the Code.