Lump sum distributions: effect of delay and....

An employee, E, retired July 1, 1992 and will receive periodic qualified retirement plan distributions through Dec. 31, 1994. E will attain age 59 1/2 on Jan. 1, 1995 and will receive the remaining balance in his account from the plan's trust on Feb. 1, 1995. Can the 1995 receipt qualify as a lump-sum distribution?

A lump-sum distribution from a qualified retirement plan may be eligible for favorable tax treatment if the conditions specified in Sec. 402(d)(4)(A) and (F) are met. The basic requirement for a lump-sum distribution is that the total balance in the employee's account must be distributed within one tax year. The lump-sum distribution does not have to be received in one payment; the balance may be paid in installments during the tax year. The distribution also must be made - as a result of the employee's death; - after the employee attains age 59 1/2; - due to the employee's separation from service (if not self-employed); or - after the employee becomes disabled (if self-employed).

Regs. Sec. 1.402(a)-1(a)(6)(iii) provides:

If an employee retires and commences to receive an annuity but subsequently,

in some succeeding taxable year, is paid a lump sum in settlement of all future annuity payments, the capital gains treatment does not apply to such lump sum settlement paid during the lifetime of the employee since it is not a payment on account of separation from the service, or death after separation, but is on account of the settlement of future annuity payments.

For instance, if an employee separates from service after attaining age 59 1/2, receives benefits in installment payments, and then takes the balance to his credit under the qualified retirement plan in a subsequent tax year in lieu of the remaining installment payments, the payout will not qualify as a lump-sum distribution; see Prop. Regs. Sec. 1.402(e)-2(d)(1)(ii)(C). (See also Letter Rulings 7909020 and 8917020, in which the remaining balance was distributed to the employee before he attained age 59 1/2.)

In Letter Ruling 9031028, a 73-year-old individual began receiving minimum annual distributions in 1985. His remaining account balance was distributed in 1990 while he continued to be employed by the employer. The IRS held that the 1990 distribution did not qualify as a lump-sum distribution, reasoning that a distribution would qualify as a lump-sum distribution only if the entire balance in the employee's account was distributed within one tax year determined as of the first distribution received after one of the four events set forth in Sec. 402(d)(4)(A).

Thus, it would appear that each of these events could be a separate "trigger" to qualify a distribution of a remaining balance as a lump-sum distribution. Therefore, E's 1995 receipt should qualify as a lump-sum distribution. (This conclusion was unofficially and informally confirmed with an Employee Benefits Specialist in the IRS National Office).

Under HR 13, introduced in the House of Representatives on Jan. 5, 1993, the following new treatment is proposed for lump-sum distributions for years beginning after 1993: "The bill repeals the special 5-year forward income averaging rule. The bill preserves the transition rules adopted in the Tax Reform Act of 1986." Under this proposal, persons eligible for these transition rules would be able to continue to elect five- and 10-year averaging and capital gains treatment as under existing law.