Rev. Rul. 60-292

Advice has been requested whether the amount standing to the credit of an employee in a qualified employees' pension trust is made available to him where, upon termination of service, a withdrawal of such amount would subject the employee to a loss of all prior service credits upon later reemployment; and whether a total distribution of such amount several years after the employee's termination of service may be treated as a long-term capital gain to the extent of the excess over the employee's contribution.

An employer established a retirement plan for the benefit of his employees. The plan meets the requirements of section 401(a) of the Internal Revenue Code of 1954 and the trust forming a part thereof is exempt from income tax under section 501(a) of the Code. Under the terms of the plan, an employee-participant who terminates his service prior to becoming eligible for benefits has the right (1) to take a lump-sum distribution of the amount standing to his credit in the trust fund at the date of separation from service or (2) to leave such amount standing to his credit, at interest, for a period up to five years. Should the separated employee elect not to withdraw the amount due him upon separation and then, within five years, reenter the employer's service, he would be entitled to receive credit toward retirement for all prior service. However, should he withdraw the amount to his credit, he would forfeit the right to any prior service credits upon reemployment.

Under these circumstances, an employee-participant severed his connection with the employer. He elected not to withdraw the amounts accumulated in his account in the trust fund when he separated from service. Four years later he requested a withdrawal and was paid a lump-sum total distribution consisting of his own contributions plus the interest accrued thereon before and after the date of his separation from service.

Paragraph (1) of section 402(a) of the Code provides, in effect, that the amount actually distributed or made available to any distributee by any employees' trust described in section 401(a) which is exempt from tax under section 501(a) shall be taxable to him, in the year in which so distributed or made available, under section 72 (relating to annuities) except that section 72(e)(3) (relating to the treatment of certain lump sums) shall not apply.

Paragraph (2) of section 402(a) provides in substance that if the total distributions payable, under such an exempt trust, are paid to the distributee within one taxable year of the distributee on account of the employee's death or other separation from the service or on account of the employee's death after such separation from service, the amount of such distribution, to the extent exceeding the 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.

Revenue Ruling 55-423, C.B. 1955-1, 41, holds that a participant's interest under an exempt employees' trust is not made available to him within the purview of section 402(a)(1) of the Code if there are substantial conditions or restrictions on his right of withdrawal.

Under the instant plan, a participant who withdraws the amount accumulated to his account in the trust fund (participant's contributions plus interest thereon) at the time of his separation from service immediately suffers a loss of all prior service credits to which he was theretofore entitled. This, in the presence of such facts, constitutes a substantial condition. Therefore, in accordance with the above cited Ruling, neither the amount to the credit of an employee in a qualified employees' trust at the date of his separation from the service of the employer nor the amount of any increment credited thereon after such date is made available to him prior to the time the amounts are actually distributed to him if the withdrawal of such amounts would subject the employee to a loss of all prior service credits to which he was theretofore entitled.

As will be noted from the provisions of section 402(a)(2) of the Code, if everything to which the employee is entitled under the trust, at the time of separation from service, is paid within one taxable year of the employee, the amount so paid is treated as a long-term capital gain to the extent of the excess of the amount received over the employee's contributions. Thus, even though the participant here under consideration did not receive a distribution of the amount to his credit under the trust fund until four years after his separation from service, he did receive everything to which he was entitled at the date of his separation from service in one taxable year.

Accordingly, it is held that a distribution by the qualified trust to the employee in one taxable year of the total amount standing to his credit at the date of termination of service will be accorded long-term capital gain treatment to the extent it exceeds the employee's own contributions. Any increment credited to the employee's account subsequent to the date of his termination of service is taxable to him as ordinary income in the year of distribution since it is not a part of the balance to the credit of the employees account which becomes payable on account of his separation from the service. (See section 402(a)(3)(c) of the Code.)

However, where the delay in distribution is occasioned by administrative problems of the plan and the total amount of the distribution (amount standing to the credit of the employee at the time of separation and any increment accruing from that date to date of payment) is made in one taxable year of the employee as soon as administratively feasible after such separation, the Internal Revenue Service will, in the interest of convenience in administration, consider such an amount in excess of his contributions as a long-term capital gain. Whether any delay in distribution is occasioned by administrative problems of the plan and whether the distribution is made `as soon as administratively feasible' are to be determined on the basis of the facts and circumstances in each particular case.