PLR 1021042: IRS explained pension payment exclusions and prior-year amendments

Plain-English summary

The IRS addressed how a taxpayer and surviving beneficiary should calculate the nontaxable portion of pension payments from a qualified plan. Because the payments were a joint and survivor annuity, the exclusion is calculated under the Simplified Method using the annuitants' ages at the annuity starting date and a divisor of 410. The IRS stated that the taxpayer could amend eligible prior-year returns to claim the proper annual exclusion, subject to the applicable limitations period. It rejected proposed methods that would recover several years of missed exclusions in a single year or use a later date as the annuity starting date.

Ruling snapshot

• Question: How should the taxpayer calculate the excludible pension amount and correct prior-year returns?
• Outcome: Mixed
• Key authorities: IRC §§ 72, 401(a), 451, and 6110; Treas. Reg. § 1.72-4(b)(1)

Full text (IRS public release)

Significant Index Number 0072-00.00

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

201021042

MAR 03 2010

A =
B =
C =

Dear

This is in reply to your request for a ruling concerning the income tax treatment of
pension benefits received from C.

According to the information submitted, you commenced pension benefits on
August 31, 2002. You are entitled to a monthly amount of payable for
your life. If B survives after your death, she will receive benefits of per
month for the rest of her life. C is a pension plan qualified under section 401(a)
of the Internal Revenue Code (Code). You made after-tax contributions of
the retirement fund. You were born February 2, B was born
September 24, The 1099-R forms you received from 2002 forward
incorrectly stated the taxable amount to be the gross amount paid to you. You
did not exclude any portion of the amounts received in prior years’ income tax
returns.

You requested a ruling on two issues related to the income tax treatment of these
benefits:

(1) How should you compute the taxable portion of the pension for the
current year; and

(2) how should you correct prior years’ returns to reflect the correct
exclusion amounts for the pension payments for those years.

In addition, you suggested two options for the second issue. The first option is,
beginning with the earliest year for which you can file an amended return, to treat
the entire amount received as non-taxable, until you have caught up to the
appropriate recovery amount for the current year as if you had treated the correct
amount as excludible each year. The second option suggested is to treat the
earliest year for which you can file an amended return as the annuity starting
date and compute the exclusion amount based on that assumption.

LAW and REGULATIONS

Section 72(b) of the Code excludes from gross income that portion of the
payments which represents a return of the investment in the contract. After-tax
contributions would constitute the investment in the contract. Section 72(d) of
the Code provides that for a pension under a qualified plan, the excludible
amount is determined using the Simplified Method, which consists of dividing the
investment in the contract by a divisor based on the age of annuitant (or sum of
ages of annuitant and survivor in the case of a joint and survivor annuity) at the
annuity starting date. The result is the monthly excludible amount. The total
amount excludible in a year is this monthly amount times the number of months
for which payments were paid to the taxpayer during the year.

Section 1.72-4(b)(1) of the Federal Income Tax Regulations (Regulations)
defines the annuity starting date as the first day of the first period for which a
payment is received.

Section 1.451-1(a) provides that if income was improperly included in gross
income in a prior year and that year is still within the limitation period, the
taxpayer may file an amended return correcting the gross income. IRS
Publication 17 provides that a tax refund for an overpayment may be claimed by
an amended return within 3 years of the date you filed your return or 2 years of
the date you paid the tax, whichever is later.

ANALYSIS and COMPUTATION

The annuity starting date is August As of that date, A was age 51, and
B was 44. The sum of these ages is 95. Under the Simplified Method of Section
72(d) of the Code, for a joint and survivor annuity where the sum of the ages at
the annuity starting date is less than 111, the divisor is 410. The monthly
excludible amount is the investment in the contract, (equal to the
employee after-tax contributions) divided by 410, or The annual
excludible amount, for any year in which you are paid 12 payments is 12 times
or These amounts are excludible each year until the total
amount excluded under the contract is equal to your original contribution amount,
If B survives after your death, she continues taking the same
exclusions that you would have been eligible for had you continued receiving the
payments.

Nothing in Section 72 of the Code or the Regulations thereunder allows the re-
computation of the annual excludible amount based on what amounts were
actually excluded from the taxpayer’s income. Each year’s exclusion is limited to
12 times the monthly excludible amount computed under the Simplified Method.

Therefore, your first suggested option for dealing with the prior tax years is not
permissible. In addition, the rules for the Simplified Method require that the
computation be based on the ages of the annuitants at the annuity starting date.
Therefore, your second suggested option for dealing with the prior tax years is
also not permissible. However, even if it were permitted, the sum of the ages of
the annuitants would in any case remain less than 111, so the divisor would
remain 410, and the monthly excludible amount would be unchanged.

CONCLUSION

With regard to Issue (1), the monthly excludible amount is and the
amount excludible for each year for which 12 payments are made is
These amounts are excludible each year until the total amount excluded under
the contract equals the investment in the contract,

With regard to Issue (2), you may amend income tax returns for prior years to
reflect the annual excludible amount of with respect to each year for
which an amended return is allowable. Generally an income tax return may be
amended within three years of the date upon which the original return was due,
or within two years from the date the income tax was paid, whichever is later.

With regard to your suggested options for issue (2), you may not recover all of
the amounts that could have been treated as excludible from 2002 to the current
year by treating the entire amount as excludible in a single year, nor may you
treat a date in a later year as the annuity starting date for purposes of computing
the monthly amount excludible under the Simplified Method.

A copy of this ruling should be attached to your Federal income tax return. We
have included a copy for that purpose.

If you have any question concerning this matter, please contact

Sincerely,

David M. Ziegler
Manager, Actuarial Group 2
Employee Plans Technical