Rev. Rul. 65-268

Advice has been requested whether long- term capital gains treatment may be accorded the amount of cash received by a taxpayer from the surrender of annuity contracts in a year subsequent to the year in which the contracts were distributed from a qualified employees' trust, which contracts represented the total amount standing to the credit of the employee at the time of his separation from the service of the employer.

For purposes of this question, and as used throughout this Revenue Ruling, the term `annuity contracts' means contracts meeting that part of the definition contained in section 401(g) of the Internal Revenue Code of 1954 to the effect that the term `annuity' `* * * does not include any contract * * * issued after December 31, 1962, which is transferable, if any person other than the trustee of a trust described in section 401(a) which is exempt from tax under section 501(a) is the owner of such contract * * *'

The taxpayer was an employee-participant in a noncontributory employees' pension plan and trust established by his employer. The plan meets the requirements for qualification under section 401(a) of the Code and the trust is exempt from tax under section 501(a) of the Code. Upon separation from the service of his employer, the taxpayer received pursuant to provisions of the plan several annuity contracts from the trust representing the balance to his credit in the trust. In a year subsequent to the year of distribution, the taxpayer surrendered the annuity contracts for their cash value.

Section 402(a)(2) of the Code provides, in part, that in the case of a qualified and exempt employees' trust, if the total distributions payable with respect to any employee are paid to the distributee within 1 taxable year of the distributee on account of the employee's death or other separation from the 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 6 months.

Section 1.402(a)-1(a)(6)(ii) of the Income Tax Regulations 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.

In accordance with section 1.402(a)-1(a)(2) of the regulations, if a qualified employees' trust purchases an annuity contract for an employee and distributes it to the employee in a year for which the trust is exempt, the contract containing a cash surrender value which may be available to an employee by surrendering the contract, such cash surrender value will not be considered income to the employee unless and until the contract is surrendered. The last sentence of section 1.402(a)-1(a)(2) of the regulations provides a different rule with respect to a transferable contract issued after 1962.

Revenue Ruling 55-298, C.B. 1955-1, 394, holds, in part, that where, by reason of the termination of an employee's service, the employee receives his `total distributions payable,' which includes an annuity contract, and surrenders the contract for its cash value during the taxable year in which the distribution is received, `long term capital gains treatment' will be accorded such total distribution. The ruling provides further, however, that `long term capital gain treatment' may not be accorded the proceeds of the contract where the terminating employee defers the surrender of the contract where the terminating year subsequent to the year of distribution.

Since the taxpayer in the instant case had separated from the service of his employer, he would have been entitled to long-term capital gains treatment on the `total distributions payable' on account of such separation, to the extent that the distributions of the annuity contracts were includible in his gross income in the same taxable year in which distributed. However, no amount is includible in gross income unless and until such contracts are actually surrendered for their cash values. Since the taxpayer had not surrendered such contracts in the same taxable year in which the `total distributions payable' were made, no amounts would have been includible in his gross income in such year. He would have amounts includible in gross income in the taxable year following the year of distribution inasmuch as he surrendered the contracts in such year. Nevertheless, the long-term capital gains treatment would not apply in such subsequent year inasmuch as the taxpayer was not in receipt of `total distributions payable' from the trust in the same taxable year in which the contracts were surrendered for their cash values.

Accordingly, it is held that the taxpayer is not entitled to apply long-term capital gains treatment under the provisions of section 402(a)(2) of the Code, to the amounts received upon surrender of the contracts in a later year inasmuch as such income was not realized in the year the annuity contracts were distributed by the trust. Amounts received upon surrender of the contracts in any year subsequent to the year of distribution from the trust, are includible in the gross income of the taxpayer to the extent provided under section 72(e) of the Code.

Compare Revenue Ruling 65-267, page 141 of this Bulletin, which deals with a case in which cash and an annuity contract are distributed by an employees' trust as a `total distributions payable' to a distributee simultaneously, and the annuity contract is not surrendered in the same taxable year in which received.