Rev. Rul. 60-84

Advice has been requested whether a lump-sum distribution to an employee, upon termination of service, of the total amount standing to his credit in a profit-sharing trust, which includes a paid-up life insurance contract purchased for his benefit, would adversely affect the exempt status of the trust under a plan which meets the requirements of section 401(a) of the Internal Revenue Code of 1954, and whether the capital gain provisions of section 402(a)(2) apply to such distribution which includes the cash value of the life insurance contract.

An employees' profit-sharing plan and trust established by an employer on behalf of his employees has been held to meet the qualifications of section 401(a) of the Internal Revenue Code of 1954 and to be exempt under section 501(a) of the Code. Under the terms of the plan, the trustee is authorized to invest in life insurance contracts on the lives of the participating employees. The amount so invested was less than 50 percent of the amount allocated to the account of any participant at any given time. The plan and trust, which provided for deferred vesting, were amended to provide that on termination of employment an employee's rights would be fully vested in the cash and insurance contracts then held by the trustee for his benefit. Upon the termination of services of an employee, the trustee will deliver the insurance contracts to the employee and the cash accumulated in his account will be paid in a lump sum. The employee will have the right and privilege of conversion under the contract.

Revenue Ruling 54-51, C.B. 1954-1, 147, sets forth the principle that if amounts allocated to the respective participants in any type of qualified plan are to be used to provide such participants with life insurance protection, the life insurance feature must be incidental and subordinate to the primary purpose of the plan, which is to permit the employees of their beneficiaries to participate in a plan of deferred compensation. See section 1.401-1(b)(1) (i) and (ii) of the Income Tax Regulations and Revenue Ruling 57-163, C.B. 1957-1, 128, Part 2(k)(2).

Revenue Ruling 54-51 holds that an investment by a profit-sharing trust in an ordinary life insurance contract for the purpose of providing death benefits for each insurable participant under the trust will be considered incidental and subordinate to the primary purpose of a qualified profit-sharing plan and will not adversely affect the qualification of the plan where (1) the aggregate premiums for life insurance in the case of each participant are less than one-half of the aggregate of the contributions allocated to him at any particular time, and (2) the plan requires the trustee to convert the entire value of the life insurance contract at or before retirement to provide periodic income so that no portion of such value may be used to continue life insurance protection beyond retirement.

However, section 1.402(a)-1(a)(2) of the Income Tax Regulations provides that the entire cash value of a life insurance contract distributed by an exempt trust must be included in the distributee's income in accordance with section 402(a) of the Code where it is not converted, within 60 days after the distribution, into a contract under which no part of any proceeds payable on death at any time would be excludable under section 101(a) of the Code.

Accordingly, it is held that where a paid-up life insurance contract is distributed to a participant by an exempt trust forming a part of a profit-sharing plan, a failure to convert the contract so that no portion is used to continue life insurance protection beyond retirement will not cause the trust and plan to fail of qualification if they otherwise meet the requirements of section 401(a) of the Code.

Revenue Ruling 54-51 and Part 2(k)(2) of Revenue Ruling 57-163 are accordingly amplified.

Furthermore, section 1.402(a)-1(a)(6)(i) of the regulations states that if the total distributions payable with respect to any employee under a trust described in section 401(a) which in the year of distribution is exempt under section 501(a) are paid to, or includible in the gross income of, the distributee within one taxable year of the distributee on account of the employee's death or other separation from the service, or death after such separation from service, the amount of such distribution, to the extent it exceeds the net amount contributed by the employee, shall be considered a gain from the sale or exchange of a capital asset held for more than six months. The total distributions payable are includible in the gross income of the distributee within one taxable year if they are made available to such distributee and the distributee fails to make a timely election under section 72(h) to receive an annuity in lieu of such total distributions.

Accordingly, it is further held that where an employee, as in the instant case, receives a life insurance contract and does not convert the contract into an annuity contract within 60 days after its distribution to him, he may treat the entire cash value of the insurance contract, plus the cash amount paid to him, as gain from the sale or exchange of a capital asset held for more than six months to the extent that the sum thereof exceeds the net amount contributed by the employee.