PLR 200003058: Employer stock distribution and IRA rollover form one lump sum distribution

Plain-English summary

A retired employee planned to receive all employer stock from a qualified retirement plan while moving the rest of the account to an IRA. The IRS ruled that the stock distribution and the rollover could together count as a lump sum distribution under § 402(e)(4)(B) if the entire account was distributed within one taxable year. On those facts, the stock's net unrealized appreciation could remain excluded from income until the employee disposed of the stock. The ruling assumed the plan and its trust were qualified and tax exempt, and expressed no opinion on the IRA's qualified status.

Ruling snapshot

• Question: Does rolling nonstock plan assets to an IRA prevent a same-year employer stock distribution from qualifying as a lump sum distribution?
• Outcome: Approved, assuming distribution of the whole account within one taxable year under the plan's terms.
• Key authorities: IRC §§ 401(a)(31), 402(c), 402(d)(4), 402(e)(4)(B), 408(a); Treas. Reg. §§ 1.401(a)(31)-1, 1.402(c)-2.

Full text (IRS public release)

200003058

Internal Revenue Service                     Department of the Treasury
Uniform Issue List No. 402.07-00            Washington, DC 20224

In Reference to:
Date: October 29, 1999

Legend:
Corporation A = ********************
Plan X = ********************

Dear ************:

This is in response to a ruling request submitted to this office on your behalf
by your authorized representative by letter dated February 10, 1999, as
supplemented by letters dated February 19, 1999, May 13, 1999, July 27, 1999,
and August 10, 1999. You have requested rulings under section 402(e)(4)(B) of
the Internal Revenue Code (“Code”). The following facts and representations
have been submitted in support of your ruling request.

You are over age 60 and, up to your retirement on July 1, 1998, you were
an employee of Corporation A and a participant in Plan X. Your authorized
representative asserts that Plan X is qualified under section 401(a) of the Code.
You were not a participant in any other plan of Corporation A that would be
required to be aggregated with Plan X under section 402(d)(4)(C) of the Code.

Your account balance in Plan X consists of both Corporation A stock
(“Employer Stock”) and other assets. All of your pre-tax and after-tax contributions
have been invested in Employer Stock.

You wish to have all Plan X assets allocated to your account, other than the
Employer Stock, transferred to an individual retirement account (“IRA”) qualified
under section 408(a) of the Code. Consistent with the terms of Plan X, you will
elect to receive a distribution from Plan X within one taxable year of all Employer
Stock credited to your account and, in addition, you will elect to have all other Plan
X assets to the credit of your account transferred within the same taxable year to
an IRA, either by a rollover described in section 402(c) of the Code or by a direct
trustee-to-trustee transfer described in section 401(a)(31) of the Code.

You separated from service with Corporation A on July 1, 1998, and you
believe that the distribution of Employer Stock and other Plan X assets standing to
the credit of your account within the same taxable year will constitute a “lump sum
distribution” as defined in section 402(d)(4)(A) of the Code, thus allowing you to
receive deferral of income recognition on the Employer Stock until the time the
Employer Stock is disposed of. You further believe that a rollover of part of the
lump sum distribution from Plan X to an IRA would qualify as a tax-free rollover
and would not affect the status of the distribution as a “lump sum distribution” for
purposes of excluding net unrealized appreciation in securities of the employer
corporation under section 402(e)(4)(B) of the Code.

Based on the above facts and representations, your authorized
representative requests the following rulings:

1. That where a distribution is made directly to you within one taxable year
of all the Employer Stock credited to your account under Plan X and,
within the same taxable year, all remaining Plan X assets to your credit
other than the Employer Stock are, pursuant to your election under
section 401(a)(31) of the Code, paid directly to an eligible retirement
plan, the distribution may properly be treated in the aggregate as
constituting a qualifying lump sum distribution under section
402(e)(4)(B) of the Code, thus allowing you to receive deferral of income
recognition on unrealized appreciation in the Employer Stock until the
time you dispose of the stock, and

2. That for purposes of satisfying the requirement under section -
402(e)(4)(B) of the Code that any gain associated with net unrealized
appreciation in employer stock is eligible to receive deferral of income
recognition until the time of the disposition of the employer stock only if
the distribution of employer stock is made as part of a lump sum
distribution qualifying under section 402(d)(4) of the Code (without
reference to the five-year plan participation requirement under section
402(d)(4)(F)), you in receiving your total account balance within one
taxable year may transfer the Plan X assets received other than the
Employer Stock on a tax-free rollover basis to an IRA without affecting
the status of the distribution as a qualifying lump sum distribution under
section 402(e)(4)(B).

Section 402(a) of the Code provides that, except as otherwise provided in
this section, any amount actually distributed 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 the distributee, in the year of the distributee in which distributed,
under section 72 (relating to annuities).

Section 402(e)(4)(B) of the Code provides that, for purposes of subsection
(a) and section 72, in the case of any lump sum distribution which includes
securities of the employer corporation, there shall be excluded from gross income
the net unrealized appreciation attributable to that part of the distribution which
consists of securities of the employer corporation. Section 402(e)(4)(C) of the
Code provides that, for purposes of subparagraphs (A) and (B), net unrealized
appreciation and the resulting adjustments to basis shall be determined in
accordance with regulations prescribed by the Secretary.

Section 402(e)(4)(D) of the Code provides that, for purposes of this
paragraph, the term “lump sum distribution” has the meaning given such term by
subsection (d)(4)(A) (without regard to subsection (d)(4)(F)).

Section 402(d)(4)(A) of the Code provides that, for purposes of this section,
the term “lump sum distribution’ means the distribution or payment within 1 taxable
year of the recipient of the balance to the credit of an employee which becomes
payable to the recipient (i) on account of the employee’s death, (ii) after the
employee attains age 59 ½, (iii) on account of the employee’s separation from the
service, or (iv) after the employee has become disabled (within the meaning of
section 72(m)(7)), from a trust which forms a part of a plan described in section
401(a) and which is exempt from tax under section 501.

Section 402(c)(4) of the Code provides that, for purposes of this subsection,
the term “eligible rollover distribution” means any distribution to an employee of all
or any portion of the balance to the credit of the employee in a qualified trust;
except that such term shall not include (A) any distribution which is one of a series
of substantially equal periodic payments (not less frequently than annually) made
(i) for the life (or life expectancy) of the employee or the joint lives (or joint life
expectancies) of the employee and the employee's designated beneficiary, or (ii)
for a specified period of 10 years or more, (B) any distribution to the extent such
distribution is required under section 401(a)(9), and (C) any hardship distribution
described in section 401(k)(2)(B)(i)(IV).
Section 402(c)(8)(B)(i) of the Code defines “eligible retirement plan” to
include an IRA described in section 408(a).

Section 401(a)(31)(A) of the Code provides that if the distributee of any
eligible rollover distribution (i) elects to have such distribution paid directly to an
eligible retirement plan, and (ii) specifies the eligible retirement plan to which such
distribution is to be paid (in such form and at such time as the plan administrator
may prescribe), such distribution shall be made in the form of a direct trustee-to-
trustee transfer to the eligible retirement plan so specified.

Section 401(a)(31)(C) of the Code provides that, for purposes of this
paragraph, the term “eligible rollover distribution” has the meaning given such term
by section 402(f)(2)(A). Section 402(f}(2)(A) provides that the term “eligible
rollover distribution” has the same meaning as when used in subsection (c) of that
section.

Section 1.401(a)(31)-1, Q&A 5, of the Income Tax Regulations
(“regulations”) provides that an eligible rollover distribution that is paid to an
eligible retirement plan in a direct rollover is not currently includible in the
distributee’s gross income under section 402(c) of the Code and is exempt from
the 20-percent withholding imposed under section 3405(c)(2).

With respect to your ruling requests, section 402(e)(4)(D) of the Code
defines the term “lump sum distribution” as having the same meaning given such
term by section 402(d)(4)(A) without regard to the minimum period of service
requirement. Section 402(d)(4)(A) provides, in pertinent part, that the term “lump
sum distribution” means the distribution or payment within one taxable year.

Plan X provides for the distribution to an employee of the balance to the
credit in his or her account upon his or her separation from service, an event
described in section 402(d)(4)(A) of the Code which can trigger a lump sum
distribution, and you have separated from service on July 1, 1998. You intend to
notify the plan administrator that you elect to receive a distribution from Plan X
within one taxable year of all the Employer Stock in your account and, in addition,
to have all of the remaining Plan X assets credited to your account transferred
within the same taxable year to an IRA pursuant to either a rollover described in
section 402(c) or a trustee-to-trustee transfer described in section 401(a)(31).

Pursuant to section 402(d)(4)(K) of the Code, the portion of a lump sum
distribution that is not rolled over or transferred does not receive forward income
averaging treatment. However, this requirement is not included with respect to the
calculation of taxes under section 402(e)(4). Therefore, a rollover of part of a lump
sum distribution from a qualified plan to another eligible plan, including an IRA,
would not affect the status of the distribution as a qualifying lump sum distribution
for purposes of section 402(e)(4)(B).

Section 1.402(c)-2, Q&A 13(b), of the regulations provides that if an eligible
rollover distribution is paid to an individual retirement plan in a direct rollover at the
election of the distributee, the distributee is deemed to have irrevocably
designated that the direct rollover is a rollover contribution.

A review of section 401(a)(31)(C) of the Code and section 1.401(a)(31)-1,
Q&A 5, of the regulations shows that a trustee-to-trustee transfer is a type of
rollover which is exempt from the 20-percent withholding imposed under section
3405(c)(2). However, if a distributee of an eligible rollover distribution does not
elect to have the eligible rollover distribution paid directly from the plan to an
eligible retirement plan in a direct rollover under section 401(a)(31), the eligible
rollover distribution is subject to 20-percent income tax withholding under section
3405(c). Therefore, for purposes of determining whether a distribution is a
qualifying lump sum distribution for purposes of section 402(e)(4)(B), whether part
of the lump sum distribution was rolled over or transferred by a trustee-to-trustee
transfer would not change the conclusion reached on whether a distribution is a
qualifying lump sum distribution for the purposes of section 402(e)(4)(B).

Accordingly, we conclude as follows:

1. That where a distribution is made directly to you within one taxable year
of all the Employer Stock credited to your account under Plan X and,
within the same taxable year, all remaining Plan X assets to your credit
other than the Employer Stock are, pursuant to your election under
section 401(a)(31) of the Code, paid directly to an eligible retirement
plan, the distribution may properly be treated in the aggregate as
constituting a qualifying lump sum distribution under section
402(e)(4)(B) of the Code, thus allowing you to receive deferral of income
recognition on unrealized appreciation in the Employer Stock until the
time you dispose of the stock, and

2. That for purposes of satisfying the requirement under section
402(e)(4)(B) of the Code that any gain associated with net unrealized
appreciation in employer stock is eligible to receive deferral of income
recognition until the time of the disposition of the employer stock only if
the distribution of employer stock is made as part of a lump sum
distribution qualifying under section 402(d)(4) of the Code (without
reference to the five-year plan participation requirement under section
402(d)(4)(F)), you in receiving your total account balance within one
taxable year may transfer the Plan X assets received other than the
Employer Stock on a tax-free rollover basis to an IRA without affecting
the status of the distribution as a qualifying lump sum distribution under
section 402(e)(4)(B).

These rulings are based on the assumption that Plan X is qualified under
section 401(a) of the Code and its related trust is tax-exempt under section 501(a)
at all times relevant to these rulings. These rulings assume further that you will
receive the balance to your credit under Plan X within one taxable year and that
the distribution is made in accordance with the terms of the plan. This letter ruling
expresses no opinion as to the qualified status of the IRA under section 408(a)
that you intend to establish.

Please be aware that the taxable portion of an “eligible rollover distribution”
described in section 402(c)(4) of the Code is subject to the 20-percent income tax
withholding requirement under section 3405(c). However, where an eligible
rollover distribution includes employer securities, to the extent that net unrealized
appreciation in employer securities is currently excludible from gross income
pursuant to section 402(e)(4) of the Code, net unrealized appreciation is not
included in the amount of an eligible rollover distribution that is subject to the 20-
percent withholding.

This letter ruling is directed only to the taxpayer who requested it. Section
6110(k)(3) of the Code provides that it may not be used or cited by others as
precedent.

The original and a deleted copy of this letter have been sent to your
authorized representative in accordance with the instructions in a power of
attorney on file with this office.

Sincerely yours,

[signature]

John G. Riddle, Jr.
Chief, Employee Plans
Technical Branch 4

Enclosures:
Deleted copy of this letter
Notice of Intention to Disclose, Notice 437