IRS treats an ESOP distribution as a lump-sum distribution eligible for NUA treatment

Plain-English summary

The IRS ruled that a participant's 2012 distribution of the entire account balance from an employee stock ownership plan would qualify as a lump-sum distribution under IRC § 402(e)(4). The participant could therefore exclude from gross income the net unrealized appreciation in employer securities under § 402(e)(4)(B). The IRS also ruled that the participant's separate profit-sharing plan did not have to be aggregated with the ESOP when determining whether the distribution represented the participant's full account balance. Earlier diversification withdrawals from the ESOP were also not counted because the 2012 distribution followed the participant's separation from service.

Ruling snapshot

• Question: Did the participant's ESOP distribution qualify as a lump-sum distribution, and did the separate profit-sharing plan have to be aggregated with the ESOP?
• Outcome: Approved
• Key authorities: IRC §§ 402(e)(4)(B), 402(e)(4)(D), 401(a), 401(a)(28), and 4975(e)(7)

Full text (IRS public release)

201241019

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

JUL 20 2012

T. EP. RA: T2

Uniform Issue List: 402.09-00
Employer A: XXXXXX
Taxpayer M: XXXXXX
Plan X : XXXXXX
Plan Y: XXXXXX
Dear XXXXX:

This is response to the May 24, 2011 letter submitted by your authorized
representative, as supplemented by correspondence dated June 6, 2011,
December 20, 2011, and May 23, 2012, in which you request a private letter
ruling concerning the application of section 402(e) of the Internal Revenue Code
(the “Code”).

The following facts and representations have been submitted in connection with
your request:

Employer A maintains Plan X (which is an Employee Stock Ownership Plan as
defined under section 4975(e)(7) of the Code), and Plan Y, a profit sharing plan.
Both Plan X and Plan Y are qualified under section 401(a) of the Code. Taxpayer
M, as an employee of Employer A, participates in both Plan X and Plan Y.

Article 8 of Plan X contains the following provisions:

Section 8-1 provides for the distribution of balances credited to a participant’s
account by payment in a lump sum subject to the provisions of Article 8.

Section 8-4(a) provides the balances credited to a participant’s Other Investment
Accounts shall be distributed as soon as practicable after he or she terminates
employment with Employer A.

Section 8-5 contains a diversification option in accordance with section
401(a)(28) of the Code, which allows a participant who has attained age 55 and
who has completed at least 10 years of participation in Plan X the election to
withdraw an amount equal to a portion of the value of the Employer A

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stock credited to his or her plan accounts. Plan X further provides that any
amount withdrawn under section 8-5 is not treated as a distribution subject to
Article 8 of Plan X.

Plan X states that it is an ESOP within the meaning of section 4975(e)(7) of the
Code, which is a stock bonus plan which is qualified under section 401(a) of the
Code.

Prior to separating from service from Employer A, Taxpayer M elected on two
occasions to receive distributions from Plan X pursuant to the diversification
provisions under section 8-5 of Plan X. No subsequent distributions have been
made to Taxpayer M from Plan X or Plan Y. Taxpayer M separated from service
from Employer A in 2011. As provided for under the terms of Plan X, Taxpayer M
will be receiving employer securities as part of a distribution from Plan X of his
entire account balance in 2012 (“the 2012 distribution”). Taxpayer M has not
received any distributions from Plan Y and will not receive any distributions
from Plan Y in 2012.

Based upon the above facts and representations, your representative has
requested a ruling that for the purposes of section 402(e)(4) of the Code,
Taxpayer M’s distribution of his entire account balance from Plan X shall
constitute a “lump-sum distribution,” such that Taxpayer M can defer recognition
of the appreciation of the securities of Employer A in accordance with Code
section 402(e)(4)(B). Additionally, your representative has requested a ruling that
Plan X and Plan Y are not required to be treated as a single plan for the
purposes of section 402(e)(4)(D)(ii)(I) of the Code.

Section 402(e)(4)(B) of the Code provides in pertinent part that for the purposes
of section 402(a), 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)(D)(i) of the Code provides that for purposes of section
402(e)(4)(B) a lump-sum distribution means the distribution or payment within
one taxable year of the recipient of the balance to the credit of the participant which
becomes payable to the recipient (I) on account of the employee’s death, (II)
after the employee attains age 59 1/2, (III) on account of the employee’s
separation from service, or (IV) after the employee has become disabled (within
the meaning of Code section 72(m)(7)).

Section 402(e)(4)(D)(ii) of the Code requires that for the purposes of determining
the balance to the participant’s credit payable from a plan, it is necessary to
aggregate certain plans. Section 402(e)(4)(D)(ii)(I) of the Code states that all

201241019
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Section 4975(e)(7) of the Code provides, in pertinent part, that the term
employee stock ownership plan means “a defined contribution plan” which is a
stock bonus plan which is qualified, or a stock bonus plan and a money purchase
plan both of which are qualified under section 401(a).

Plan X is a stock bonus plan. Since Plan Y is a profit sharing plan, it is not
required to be aggregated with Plan X under section 402(e)(4)(D)(ii)(I) of the
Code. Accordingly, Taxpayer M’s account balance in Plan Y does not have to be
included in determining whether the 2012 distribution constitutes the balance to
the credit of Taxpayer M for purpose of applying section 402(e)(4)(D)(i) of the
Code. In addition, since the 2012 distribution is payable on account of Taxpayer
M’s separation from service the previous diversification withdrawals are also not
taken into account for purposes of determining the balance to the credit under
section 402(e)(4)(D)(i).

Accordingly, we conclude that the 2012 distribution will constitute a lump-sum
distribution under section 402(e)(4)(D) of the Code. Consequently, Taxpayer M
may exclude from gross income the net unrealized appreciation on employer
securities as provided for in section 402(e)(4)(B).

This ruling letter is based upon the assumption that Plan X and Plan Y are
qualified under section 401(a) of the Code, and that Plan X meets the
requirements of section 4975(e)(7), and that their related trusts are tax exempt
under section 501(a) at all relevant times.

If you have any questions concerning this ruling, please contact ,
ID Number **, SE:T:EP:RA:T2 at (202) -****.

Sincerely,

[handwritten signature]

Donzel H. Littlejohn, Manager
Employee Plans Technical Group 2

Enclosures:
Original Copy
Notice 437