Cost of Insured Death Benefit Coverage in Qualified Retirement Plans (PS 58 Costs)

In computing, for purposes of subsection (c)(1)(A), the aggregate amount of premiums or other consideration paid for the contract, and for purposes of subsection (e)(6), the aggregate premiums or other consideration paid, amounts contributed by the employer shall be included, but only to the extent that—

(1) such amounts were includible in the gross income of the employee under this subtitle or prior income tax laws; or

(2) if such amounts had been paid directly to the employee at the time they were contributed, they would not have been includible in the gross income of the employee under the law applicable at the time of such contribution.

Paragraph (2) shall not apply to amounts which were contributed by the employer after December 31, 1962, and which would not have been includible in the gross income of the employee by reason of the application of section 911 if such amounts had been paid directly to the employee at the time of contribution. The preceding sentence shall not apply to amounts which were contributed by the employer, as determined under regulations prescribed by the Secretary, to provide pension or annuity credits, to the extent such credits are attributable to services performed before January 1, 1963, and are provided pursuant to pension or annuity plan provisions in existence on March 12, 1962, and on that date applicable to such services, or to the extent such credits are attributable to services performed as a foreign missionary (within the meaning of section 403(b)(2)(D)(iii), as in effect before the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001).

Where any contract (or any interest therein) is transferred (by assignment or otherwise) for a valuable consideration, to the extent that the contract (or interest therein) does not, in the hands of the transferee, have a basis which is determined by reference to the basis in the hands of the transferor, then—

(1) for purposes of this section, only the actual value of such consideration, plus the amount of the premiums and other consideration paid by the transferee after the transfer, shall be taken into account in computing the aggregate amount of the premiums or other consideration paid for the contract;

(2) for purposes of subsection (c)(1)(B), there shall be taken into account only the aggregate amount received under the contract by the transferee before the annuity starting date, to the extent that such amount was excludable from gross income under this subtitle or prior income tax laws; and

(3) the annuity starting date is the first day of the first period for which the transferee received an amount under the contract as an annuity.

For purposes of this subsection, the term "transferee" includes a beneficiary of, or the estate of, the transferee.

If—

(1) a contract provides for payment of a lump sum in full discharge of an obligation under the contract, subject to an option to receive an annuity in lieu of such lump sum;

(2) the option is exercised within 60 days after the day on which such lump sum first became payable; and

(3) part or all of such lump sum would (but for this subsection) be includible in gross income by reason of subsection (e)(1),

then, for purposes of this subtitle, no part of such lump sum shall be considered as includible in gross income at the time such lump sum first became payable.

Notwithstanding any other provision of this section, if any amount is held under an agreement to pay interest thereon, the interest payments shall be included in gross income.

For purposes of this section, the term "endowment contract" includes a face-amount certificate, as defined in section 2(a)(15) of the Investment Company Act of 1940 (15 U.S.C., sec. 80a–2), issued after December 31, 1954.

Subsection (b) shall not apply in the case of amounts received after December 31, 1965, as an annuity under chapter 73 of title 10 of the United States Code, but all such amounts shall be excluded from gross income until there has been so excluded (under section 122(b)(1) or this section, including amounts excluded before January 1, 1966) an amount equal to the consideration for the contract (as defined by section 122(b)(2)), plus any amount treated pursuant to section 101(b)(2)(D) (as in effect on the day before the date of the enactment of the Small Business Job Protection Act of 1996) as additional consideration paid by the employee. Thereafter all amounts so received shall be included in gross income.

For limitation on adjustments to basis of annuity contracts sold, see section 1021.

This section provides rules for the tax treatment of premiums paid under qualified pension, annuity, or profit-sharing plans for the purchase of life insurance contracts and rules for the tax treatment of the proceeds of such a life insurance contract and of annuity contracts purchased under such plans. For purposes of this section, the term "life insurance contract" means a retirement income, an endowment, or other contract providing life insurance protection. The rules of this section apply to plans covering only common-law employees as well as to plans covering self-employed individuals.

136 T.C. No. 2

UNITED STATES TAX COURT

G. MASON CADWELL, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15456-08.

Filed January 3, 2011.

Richard H. Morton and Kevin J. Ryan, for petitioner.

Kathleen Tagni, Sherri Wilder, and Betty Clary (specially recognized), for respondent

OPINION

WELLS, Judge: This case is before the Court on petitioner's motion for summary judgment and respondent's cross-motion for summary judgment pursuant to Rule 121. Respondent determined a deficiency of $33,057 in petitioner's Federal income tax for tax year 2004 and a penalty pursuant to section 6662(a) of $6,611.

The issues to be decided as a consequence of Petitioner's motion for summary judgment and Respondent's cross-motion for summary judgment are: (1) Whether respondent was required to send a "30 day-letter" to petitioner and whether the notice of deficiency adequately sets forth respondent's position in the instant case; (2) whether petitioner must include in gross income the cash value of a life insurance policy held by a multiemployer welfare benefit plan that was converted to a single-employer welfare benefit plan during the year in issue; (3) whether petitioner must include in his gross income payments made by his employer in excess of the cost of current year life insurance protection (excess contribution); (4) whether petitioner must include in his gross income the current year cost of life insurance protection paid by his employer; and (5) whether petitioner is liable for the penalty under section 6662.

Background

The background facts are drawn from the pleadings, the parties' motions, facts deemed established, and stipulated exhibits, and are not in dispute.

At the time of filing of the petition, petitioner was a resident of North Carolina.

Petitioner is married to Jennifer K. Cadwell (Mrs. Cadwell). Petitioner and Mrs. Cadwell have two daughters, Jennifer Keady Cadwell (Jennifer) and Miranda M. Cadwell (Miranda). For his 2002 through 2004 tax years, petitioner filed Forms 1040 U.S. Individual Income Tax Return, claiming a filing status of married filing separately. For his 2002 through 2004 tax years, petitioner did not report any wages or salaries on line 7 of Form 1040.

Keady Ltd. (Keady), is a Pennsylvania S corporation organized during 1998 pursuant to sections 1361-1375. Keady is, and has always been, 100 percent owned by Mrs. Cadwell. Mrs. Cadwell is the sole director of Keady. During 2002 through 2004, Mr. Cadwell served as the secretary of Keady. Keady does not have any minutes of shareholders or directors meetings for 2002 through 2004. During 2002 through 2004, Keady's only income was its share of income (or loss) from KSM, a Limited Partnership (KSM), a Pennsylvania limited partnership formed during 1998.

During 2002 through 2004, KSM was owned as follows: 90 percent by Mrs. Cadwell; 5 percent by Keady; 2 percent by petitioner; 1.25 percent by Jennifer; and 1.5 percent by Miranda. Keady is the general partner of KSM.

During December 2002, petitioner and Mrs. Cadwell decided to obtain employee welfare benefits for petitioner, Jennifer, and Miranda through the National Benefit Plan and Trust. The respective plan documents are hereinafter referred to as the Plan and the respective trust created under the Plan is hereinafter referred to as the Trust. According to its original terms, the Plan was organized as a multiemployer welfare benefit plan pursuant to section 419A(f)(6).

On December 31, 2002, petitioner signed the document adopting the Plan as secretary on behalf of Keady. Petitioner was 64 years old at the time Keady adopted the Plan. The adoption agreement identifies Niche as the Plan sponsor, National Plan Advisory as the Plan Administrator, Wells Fargo Bank as the Plan Trustee, and National Benefit Plan and Trust as the Record Owner of the Trust's assets. Keady elected to cover petitioner, Miranda, and Jennifer with death benefits equal to 20 times the covered employee's compensation, severance benefits equal to 14.847 percent of compensation per year up to 10 years (not to exceed 200 percent), and a modified 4240 vesting schedule (vesting schedule).

Life insurance covering petitioner's and his daughters' lives was selected to fund the death and severance benefits payable under the Plan to petitioner and his daughters. For petitioner, a universal life policy with an initial death benefit of $1 million that also accumulates cash value (hereinafter referred to as the life insurance policy) was selected to fund his benefit. The life insurance policy was issued by Lincoln National Life Insurance Co. (Lincoln Life), on December 7, 2002. Petitioner named Miranda and Jennifer as beneficiaries of the life insurance policy.

On December 31, 2002, KSM paid $75,000 by check to Compass Bank, the Plan Trustee, to cover Keady's obligation under the Plan, and $2,050 for the Plan fee. Both checks were drawn on KSM's Centennial Bank account and were signed by petitioner. Lincoln Life credited petitioner's life insurance policy for a payment of $73,000 for the month ending January 6, 2003.

On May 20, 2004, KSM paid $38,800 to 419 Plan Administrators, the new Plan Administrator, to cover Keady's obligation under the Plan. Of that amount, $36,000 was paid to cover the Plan contribution and $2,800 was paid as the Plan fee. Lincoln Life credited petitioner's life insurance policy for an $18,000 payment for the month ended September 6, 2004.

On November 17, 2004, Niche sent letters to the employers participating in the Plan announcing that the Plan had been split into single-employer welfare benefit plans (SEPs or individually SEP). The reasons stated in the letters for the conversion included more employer control over Plan assets and the concern that the Plan might be subject to listed transaction penalties under section 6707A. Niche's letter acknowledged that the SEPs no longer qualified for treatment pursuant to section 419A(f)(6), and, therefore, the deductibility of the employer's contributions would be limited. Keady's employee welfare benefit plan was renamed the "Keady's Ltd. Welfare Benefit Plan", and the assets were maintained by the National Benefit Trust II.

During December 2004, the life insurance policy covering petitioner had a death benefit value equal to $1,070,529, a "fund" value equal to $70,529 and a surrender value equal to $25,237. The fund value was determined by adding the premiums paid ($91,000 = $73,000 + $18,000) and interest credited ($6,134 = $3,340 + $2,793) less mortality charges ($16,235 = $7,738 + $8,497) and other expenses ($10,370 = $7,730 + $2,640). The surrender value was the amount of cash that petitioner would receive upon surrender of the life insurance policy to Lincoln Life and was calculated by subtracting a surrender charge of $45,291 from the fund value of $70,529, yielding a surrender value of $25,237.

On April 2, 2008, respondent sent petitioner a notice of deficiency in which he determined that petitioner's gross income for 2004 should be increased by $102,039. The unreported income determined by respondent consists of: (1) The fund value of the life insurance policy as of December 31, 2004, of $70,529; (2) the excess contribution to the Plan of $18,000; and (3) the cost of term life insurance on petitioner's life for 2004 of $13,510. Petitioner timely filed a petition in this Court.

II. Whether Respondent Was Required To Send a "30 day letter" to Petitioner and Whether the Notice of Deficiency Is Invalid Because Respondent's Position Is Not Adequately Set Forth

In his petition and motion for summary judgment, petitioner contends that respondent failed to provide him with a "30-day letter", before issuing a notice of deficiency and failed to provide a specific theory of the case in the notice of deficiency. Generally, we will not look behind a notice of deficiency to examine the evidence used, the propriety of the Commissioner's motives, or administrative policy or procedure used in making the determination. Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324, 327 (1974). Accordingly, we will not look into respondent's alleged failure to issue a 30-day letter. Id.

As to whether the notice of deficiency is invalid because it insufficiently sets forth respondent's position, section 7522(a) requires that the notice "describe the basis for, and identify the amounts (if any) of, the tax due, interest, additional amounts, additions to the tax, and assessable penalties included in such notice." The purposes of section 7522 is to provide the taxpayer with notice of the Commissioner's basis for determining a deficiency. Shea v. Commissioner, 112 T.C. 183, 196 (1999). The notice needs to be sufficient to permit the taxpayer to comply with the requirement of Rule 34(b) that the taxpayer make clear and concise assignments of every error alleged against the Commissioner. Id. at 196-197. We have held that section 7522(a) does not require the Commissioner to identify the specific statutory provision supporting each adjustment in the notice of deficiency. Wheeler v. Commissioner, 127 T.C. 200, 205 (2006), aff'd, 521 F.3d 1289 (10th Cir. 2008).

Petitioner received a Form 886-A, Explanation of Items, accompanying his notice of deficiency. The Form 886-A explains how the IRS determined petitioner's deficiency and states that petitioner received income in the amount of $102,339.00 in the taxable year ending December 31, 2004, under the provisions of I.R.C. §§ 61, 72, 83 and 402(b) as a result of his participation in the National Benefit Plan and Trust Plan and its companion Trust and the Keady Ltd Welfare Benefit Plan Single Employer Plan and its companion Trust. Accordingly, we hold that the notice of deficiency, with the accompanying Form 886-A, provides an adequate basis for understanding the IRS' determination of tax due. Consequently we hold that petitioner's contention is without merit and the notice of deficiency is valid.

III. Inclusion in Petitioner's Income of the Cash Value of the Insurance Policy Upon Conversion From MEP to SEP

We next address whether petitioner must include in his gross income the cash value of the insurance policy upon conversion of the Plan from an MEP to an SEP. Respondent contends that petitioner became substantially vested in the Plan upon its conversion from an MEP to an SEP pursuant to section 1.402(b)-1(b)(1), Income Tax Regs. Petitioner contends that he has no interest in the Plan because the terms of the Plan and the involuntary nature of the conversion of the Plan from an MEP to an SEP preclude him from being "substantially" vested in the Plan or the Plan assets.

Section 402(b)(1) provides that employer contributions made to a nonexempt employee trust are included in the gross income of the employee to the extent that the employee's interest in such contribution is substantially vested (within the meaning of section 1.83-3(b), Income Tax Regs.) at the time the contribution is made. Sec. 1.402(b)-1(a)(1), Income Tax Regs. If the rights of an employee under a nonexempt employee trust become substantially vested during a taxable year of the employee and the taxable year of the trust ends with or within such year, the value of the employee's interest in the trust on the date of such change is included in the employee's gross income for that taxable year. Sec. 1.402(b)-1(b)(1), Income Tax Regs.

On November 17, 2004, Niche amended the Plan to convert the Plan from an MEP to an SEP. Keady's SEP received its proportional share of the Plan's assets. Following the conversion of the Plan, the assets in Keady's SEP could be used only to pay claims of Keady employees. The conversion of the Plan from an MEP to an SEP eliminated the risk that Keady's assets could be used to pay other employers' claims. In other words, a future condition that could have occurred under the original Plan as an MEP, i.e., another company's claim to the cash value of Keady life insurance policies, no longer existed under the Plan as an SEP.

According to its terms, Keady could terminate the SEP at any time. In the event of an employer withdrawal from the SEP, the Trust could distribute the life insurance policies to Keady, sell the life insurance policies to any interested purchaser with an insurable interest in the employees, or surrender the life insurance policies to the insurance company for their cash surrender value. Additionally, the Trust could sell petitioner his life insurance policy.

We conclude that the vesting restrictions are illusory under the circumstances of the instant case. When the Trust's assets came under Keady's exclusive control, they became subject to petitioner's control. As noted above, petitioner could terminate the SEP and have the plan assets or their cash equivalent distributed to Keady. Moreover, if the vesting schedule were to apply, the power to enforce the restrictions against petitioner would be in the hands of petitioner, his wife, or his daughters. Under such circumstances, the restrictions on petitioner's power to obtain the Plan proceeds are illusory.

On the basis of the record, we conclude that petitioner's interest in the postconversion SEP was no longer subject to a substantial risk of forfeiture; i.e., was substantially vested upon conversion of the Plan to an SEP.

Rev. Proc. 2005-25, 2005-1 C.B. 962, provides a safe harbor for determining the fair market value of a life insurance policy for purposes of applying section 402(b), and petitioner has not suggested any reason for deviating from the formula it provides. For a nonvariable or variable life insurance contract the safe-harbor fair market value is the greater of: (A) the sum of the interpolated terminal reserve and any unearned premiums plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience, and (B) the product of the PERC amount (the amount based on premiums, earnings, and reasonable charges) and the applicable Average Surrender Factor.

According to Rev. Proc. 2005-25, supra, the surrender charge should be disregarded for valuation purposes. The surrender charges apply in decreasing amounts beginning in the life insurance policy's first year and are reduced to zero in the life insurance policy's 15th year. Accordingly, it will be disregarded for purpose of valuing petitioner's interest in the life insurance policy.

On December 31, 2002, KSM paid $75,000 to the Plan Trustee to cover Keady's initial contribution and $2,050 to cover the MEP fee. Of the $75,000 payment, $73,000 was credited to petitioner's life insurance policy. On May 20, 2004, KSM contributed $36,000 for the Plan's premiums and $2,800 to cover the Plan fee. Of the $36,000 contribution, $18,000 was credited to petitioner's life insurance policy. During 2003 and 2004, petitioner's life insurance policy was also increased by interest payments of $6,134, for a total of $97,134. Petitioner's life insurance policy was decreased during 2003 and 2004 for mortality charges of $16,235 and other expenses of $10,370, respectively, for a total of $26,605. As noted above, petitioner's interest in the life insurance policy is not reduced by any surrender charges. Accordingly, we conclude that the PERC value of petitioner's interest in the life insurance policy is $70,529.

Accordingly, we hold that the cash value of the life insurance policy must be included in petitioner's gross income for his 2004 tax year pursuant to section 1.402(b)-1(b)(1), Income Tax Regs.

IV. Whether Petitioner Must Include in Gross Income the Excess Contributions

During 2004, KSM contributed life insurance policy premiums of $36,000. Petitioner's life insurance policy was credited with a payment of $18,000. Respondent concedes that $645 of the remaining $18,000 was used to pay the annual premium on Miranda's and Jennifer's policies. Respondent contends that the excess contribution, $17,355, should be included in petitioner's gross income pursuant to section 1.402(b)-1(b)(1), Income Tax Regs.

As discussed above, the parties treat petitioner's interest in the Plan before conversion as being subject to a substantial risk of forfeiture, i.e., not substantially vested. We concluded above that, following the conversion of the Plan to an SEP, petitioner's interest was substantially vested. See id. Additionally, neither party contends that the excess contribution is subject to any liabilities.

Petitioner also contends that the excess contributions have been accounted for in the cash value of the life insurance policy. Of the $36,000 contribution for life insurance protection made during 2004, $645 was credited towards Miranda's and Jennifer's life insurance policies. In the PERC calculation set forth above, $18,000 of the $36,000 was credited towards the cash value of petitioner's life insurance policy. The $17,355 excess contribution was not credited toward the cash value of the life insurance policy covering petitioner discussed in the PERC valuation above. Consequently, the inclusion of the excess contribution in petitioner's income would not be "double counting".

Accordingly, we hold that the excess contribution of $17,355 must be included in petitioner's gross income for his 2004 tax year.

V. Whether Petitioner Must Include the Cost of the Life Insurance Protection in His Gross Income

Respondent contends that the cost of life insurance protection Keady provided to petitioner during 2004 was an economic benefit and, therefore, should be included in his gross income under section 402(b) or section 61. Petitioner contends that neither section is applicable. We agree with respondent that the value of the cost of life insurance protection is included in petitioner's gross income under section 61.

Gross income includes income from whatever source derived, including income for services. Sec. 61(a). The term "gross income" is construed broadly, as opposed to exclusions from gross income, which are construed narrowly. Commissioner v. Schleier, 515 U.S. 323, 328 (1995). Generally, life insurance premiums paid by an employer on the life of his employee, where the proceeds of such insurance are payable to the beneficiary of the employee, are included in the gross income of the employee. Sec. 1.61-2(d)(2)(ii)(A), Income Tax Regs.

We note that section 1.61-2(d)(6), Income Tax Regs., does not apply, because, pursuant to section 1.83-3(e), Income Tax Regs., current life insurance protection is not "property". As noted above, section 402(b)(1) is inapplicable. Moreover, the cost of life insurance protection generally is taxable under section 61 and the regulations pursuant to section 61. Sec. 1.83-6(a)(2), Income Tax Regs.

Petitioner received life insurance protection pursuant to the payments made by KSM to purchase the life insurance policy on petitioner's life. That life insurance protection was a valuable benefit and significant accession to petitioner's wealth; i.e., $1 million payable to his daughters if he were to die during 2004. See United States v. Burke, 504 U.S. 229, 233 (1992) ("Congress intended through § 61(a) * * * to bring within the definition of income any accession to wealth" (quoting Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955))).

Accordingly, we hold that petitioner must include in his gross income for his 2004 tax year the current year cost of life insurance protection.

Petitioner contends that the fair market value of the cost of life insurance is $8,496; i.e., the 2004 mortality charges. Respondent contends that the value of the life insurance protection is $13,510; i.e., the annual cost, according to Notice 2001-10, Table 2001, 2001-1 C.B. 459, 463, for $1 million worth of life insurance for an individual who is 66 years old. The regulations provide little guidance in determining the cost of life insurance protection that is included in gross income pursuant to section 61. Accordingly, it is helpful to examine how other parts of the Code, including provisions governing the taxation of split-dollar life insurance and group term life insurance, calculate the cost of 1 year of life insurance protection.

Generally, split dollar life insurance is any arrangement between an owner and a nonowner of a life insurance contract where one party pays the premiums and is entitled to recover all or a portion of such premiums from the proceeds of the life insurance contract and the arrangement is not group term life insurance. Sec. 1.61-22(b)(1), Income Tax Regs. Rev. Rul. 64-328, 1964-2 C.B. 11 provides that an employee must include in gross income the annual value of the benefit the employee receives under a split-dollar arrangement, which is an amount equal to the 1-year term cost of life insurance protection to which the employee is entitled from year to year, less the portion, if any, the employee provides. See also Johnson v. Commissioner, 74 T.C. 1316, 1322 (1980). We note that Rev. Rul. 64-328, supra, is not an attempt to include in gross income the entire life insurance premium but rather only the cost of the current year's life insurance protection. The 1-year cost of life insurance protection is the amount to be determined in the instant case.

Rev. Rul. 64-328, supra, provides that the cost of life insurance protection should be calculated using the P.S. 58 rates found in Rev. Rul. 55-747, 1955-2 C.B. 228. Notice 2001-10, supra, revoked Rev. Rul. 55-747, supra, and provided Table 2001 as a substitute for the P.S. 58 rates.

In Curcio v. Commissioner, T.C. Memo. 2010-115, we used the rates in section 1.79-3(d), Income Tax Regs. as a "rough estimate" of the cost of life insurance protection to decide whether the taxpayer's expenses for life insurance were deductible pursuant to section 162(a). Table 2001 is an updated version of the rates found in section 1.79-3(d), Income Tax Regs. See Notice 2001-10, 2001-1 C.B. at 462 ("Table 2001 is based on the mortality experience reflected in the table of uniform premiums promulgated under section 79(c) of the Code (see § 1.79-3(d) of the regulations) with extensions for ages below 25 and above 70, and the elimination of the five-year age brackets"); see also Notice 2002-8, 2002-1 C.B. 398.

Accordingly, we conclude that for purposes of the instant case, Table 2001 is a reasonable estimate of the cost of 1 year of life insurance protection.

Pursuant to Table 2001 the cost of $1 million worth of life insurance coverage for a 66 year-old is $13,510. As neither party has argued that the life insurance policy in issue is split-dollar life insurance we need not address any issue regarding the effect of split-dollar life insurance on the calculation of the cost of the life insurance policy in issue. Additionally, neither party contends that petitioner paid for such life insurance coverage.

We note that, if we were to include the entire $13,510 amount in petitioner's income, there would be double counting. The life insurance policy in issue may qualify as split-dollar life insurance pursuant to sec. 1.61-22(b)(2), Income Tax Regs. However, the outcome would be the same if we classified the life insurance policy in issue as split-dollar life insurance.

Petitioner's gross income already includes the cash value of the life insurance policy calculated under the PERC method. That method takes into account the premiums paid and any other income the life insurance policy earns, but it subtracts mortality charges and other expenses. To include the entire $13,510 in addition to the PERC value would partially double count a portion of the premium payments that has already been included in the PERC amount.

Instead, the value for current year life insurance protection should be calculated by adding the mortality charges ($8,496) and other expenses ($2,640). The sum of $11,136 reflects the charges for current year life insurance that were already subtracted from the fair market value calculation determined using the PERC amount, pursuant to Rev. Proc. 2005-25, supra. Therefore, we conclude that when the PERC formula has been used to calculate the fair market value of the policy, the cost of insurance may be calculated by adding the mortality charges and other expenses.

Petitioner contends that we should only consider the current mortality charges rather than the Table 2001 rates. Petitioner in essence contends that the current mortality charges are the "insurer's published premium rates for one-year term insurance" pursuant to Rev. Rul. 66-110, 1966-1 C.B. 12. Pursuant to Notice 2002-8, 2002-1 C.B. at 398-99, the insurer's published premium rates may be used only if the taxpayer can show that the insurer generally makes the availability of such rates known to persons who apply for term insurance coverage from the insurer and the insurer regularly sells term insurance at such rates to individuals who apply for term insurance coverage through the insurer's normal distribution channels. Petitioner does not argue that the requirements of Notice 2002-8, supra, are unreasonable or incorrect. Furthermore, on a motion for summary judgment that is properly made and supported, the opposing party must set forth specific facts showing that there is a genuine issue for trial. Rule 121(d). Petitioner does not allege that he has any evidence that would satisfy the requirements of Notice 2002-8, supra. Furthermore, petitioner does not suggest that there is a material factual issue that could be resolved at trial. Accordingly, we conclude that summary judgment is appropriate on this issue and that the requirements of Notice 2002-8, supra, have not been met. Therefore, we hold that petitioner must include in his gross income for his 2004 tax year the cost of current year life insurance protection of $11,136.

VI. Whether Petitioner Is Liable for the Section 6662 Penalty

Respondent contends that petitioner is liable for the accuracy-related penalty pursuant to section 6662(a) on account of a substantial understatement of tax, or in the alternative, on account of negligence or disregard of rules and regulations. See sec. 6662(b)(1) and (2).

A substantial understatement of income tax is an understatement that is greater than 10 percent of the tax required to be shown on the return for the taxable year or $5,000. Sec. 6662(d)(1)(A). An understatement is the excess of the amount required to be shown on the return for the taxable year over the amount actually shown on the return. Sec. 6662(d)(2).

The record reveals that petitioner's understatement will be greater than $5,000. Petitioner has failed to establish any defense to the accuracy-related penalty.

Consequently, we hold that petitioner is liable for the accuracy-related penalty under section 6662(b)(2).

We shall therefore grant respondent's cross-motion for summary judgment and deny petitioner's motion for summary judgment.

We have considered all of the issues raised by the parties, and, to the extent they are not discussed herein, we conclude that they are without merit, unnecessary to reach, or moot.

To reflect the foregoing,

An order and decision will be entered under Rule 155.

T.C. Memo. 2016-182

UNITED STATES TAX COURT

DORA MARIE MARTINEZ AND CARLOS GARCIA, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8483-15.

Steven Ray Mather, for petitioners.

Filed September 28, 2016.

Jenny R. Casey and Sebastian Voth, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Judge: Respondent determined an $8,320 deficiency and a $1,664 penalty under section 6662(a) with respect to petitioners' Federal income tax for 2012. The issues for decision are: (1) whether the unpaid balances of loan amounts that Dora Martinez (petitioner) borrowed from her section 403(b) qualified employer retirement plan (QP) were deemed distributions of taxable income in 2012 and subject to a 10% additional tax, (2) whether petitioners had other unreported income in 2012 of $300 of interest, $195 of cost of current life insurance protection, and $162 of education program payments received as a distribution from their section 529 qualified tuition program (QTP) and subject to a 10% additional tax, and (3) whether petitioners are liable for the section 6662(a) penalty for 2012. Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. Petitioners resided in California when they filed their petition.

For the period relevant to this case, petitioner was employed as a teacher by the Los Angeles Unified School District (LAUSD), and Garcia, her spouse, was employed as a truck driver by Kellogg Sales Co. Petitioner decided to borrow from her LAUSD QP as a means of avoiding foreclosure on their residence.

On July 29, 2010, she requested two loans from her LAUSD QP: a loan of $28,899 from an account administered by North American Co. for Life & Health Insurance (NAMCO), and a loan of $4,085 from an account administered by Midland National Life Insurance Co. (Midland). Each loan agreement indicated that the loan was to be repaid in quarterly payments over a five-year period and also indicated, by a checked box, that the new loan "IS NOT TO BE USED AS A RESIDENTIAL LOAN." Petitioner signed both loan agreements, representing that she understood their terms and acknowledging that "any loan not in accordance with the requirements of I.R.C. para. 72(p) shall be considered as a deemed distribution and be reported as taxable income" and accepting "full responsibility for compliance with those requirements." On August 12, 2010, NAMCO issued a check to petitioner for $28,899, and Midland issued a check to her for $4,085.

Petitioners made initial payments on the loans but stopped as of May 2012. They nevertheless continued to receive loan repayment notices from both NAMCO (up to January 2016) and Midland (up to October 2012). As a result of the loan payments having not been made, NAMCO and Midland determined that petitioner had defaulted on the loans as of November 2012. NAMCO and Midland deemed the loan balances, $20,581.85 and $2,906.92, respectively, to be taxable distributions in 2012. They each issued to petitioner a 2012 Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., that reported each gross distribution (i.e., $20,581.85 for NAMCO and $2,906.92 for Midland) as fully taxable and indicated a distribution code of "L", designating a deemed distribution.

In 2012 petitioner held an insurance policy with Conseco Life Insurance Co. (Conseco) through her employer. Using standard calculations, Conseco subsequently determined that, for 2012, petitioner received a benefit for the cost of life insurance protection of $195.68. Conseco issued to petitioner Form 1099-R reporting the $195.68 as a fully taxable distribution and indicating a distribution code of "9", designating the cost of current life insurance protection.

Petitioners maintained a QTP for their children. In 2012, petitioner withdrew $162 from the QTP. She also received interest income of $300 in 2012.

Petitioner was 43 years old as of December 31, 2012.

On their jointly filed 2012 Form 1040, U.S. Individual Income Tax Return, petitioners reported only their wage income. They did not report income from the deemed distributions of the QP, the earned interest, the cost of current life insurance protection, or the withdrawal from the QTP.

OPINION

In unreported income cases, where there is no question that the taxpayer received the unreported income in issue, the taxpayer has the burden of proving by a preponderance of the evidence that the deficiency determination was arbitrary or erroneous. See Hardy v. Commissioner, 181 F.3d 1002, 1004-1005 (9th Cir. 1999), aff'g T.C. Memo. 1997-97; Tokarski v. Commissioner, 87 T.C. 74, 76-77 (1986). Petitioner admitted during her testimony that she received the proceeds of the two QP loans and $162 from the QTP (contrary to the assertion in petitioners' posttrial brief), and petitioners stipulated that petitioner received $300 of interest income.

At trial petitioner argued, however, that she never received money from Conseco. See Hardy v. Commissioner, 181 F.3d at 1004 (requiring, where receipt of income is not evident, that the Commissioner introduce some substantive evidence that the taxpayer received unreported income). Petitioner nevertheless testified that she held a life insurance policy with Conseco in 2012, and the parties stipulated as an exhibit Form 1099-R--issued by Conseco and reporting petitioner's cost of current life insurance protection of $195.68--and supporting records showing how Conseco determined that cost.

Petitioner would not have actually received $195 because, as discussed below, the cost of current life insurance protection is a taxable economic benefit and not an actual payment to the participant. The $195.68 shown on Form 1099-R is linked to a life insurance policy that petitioner held with Conseco during 2012 and is also supported by Conseco's calculation worksheets and other records. See Feder v. Commissioner, T.C. Memo. 2012-10, slip op. at 7 (ruling that an initial burden of production was met where the Commissioner had shown that income reported on Form 1099-R was linked to a life insurance policy held by the taxpayer).

Respondent has therefore satisfied any initial burden of production regarding the unreported income in issue. Petitioners must come forward with proof that respondent's determination is arbitrary or erroneous or that this income is otherwise not taxable.

QP Deemed Distributions

Section 402(a) provides generally that, pursuant to section 72, distributions from a QP are taxable to the distributee for the taxable year of the distribution. See Molina v. Commissioner, T.C. Memo. 2004-258, slip op. at 6. The proceeds of a loan from a QP to a participant are treated as--or deemed to be--a distribution and therefore usually includible in the participant's income. Sec. 72(p)(1)(A); see Duncan v. Commissioner, T.C. Memo. 2005-171, slip op. at 5.

Section 72(p)(2), however, provides an exception to a loan's being treated as a taxable distribution where the principal amount of the loan (when added to the outstanding balance of all other loans from the same plan) does not exceed a specified limit, see sec. 72(p)(2)(A), and where the loan meets the requirements provided by section 72(p)(2)(B) and (C), as follows:

SEC. 72(p). Loans Treated as Distributions.-

(2) Exception for certain loans.-

(B) Requirement that loan be repayable within 5 years.-

(i) In general.--Subparagraph (A) shall not apply to any loan unless such loan, by its terms, is required to be repaid within 5 years.

(ii) Exception for home loans.--Clause (i) shall not apply to any loan used to acquire any dwelling unit which within a reasonable time is to be used (determined at the time the loan is made) as the principal residence of the participant.

(C) Requirement of level amortization.--Except as provided in regulations, this paragraph shall not apply to any loan unless substantially level amortization of such loan (with payments not less frequently than quarterly) is required over the term of the loan.

See also sec. 1.72(p)-1, Q&A-3(b), Income Tax Regs. (requiring, additionally, that the loan be "evidenced by a legally enforceable agreement"). The substantially level amortization requirement of section 72(p)(2)(C) has been interpreted as requiring that payment of principal and interest be made in substantially level amounts over the term of the loan. See Plotkin v. Commissioner, T.C. Memo. 2001-71, slip op. at 10 (citing Estate of Gray v. Commissioner, T.C. Memo. 1995-421).

The section 72(p)(2) exception to a loan's being deemed a distribution ceases to apply when the "loan from a qualified employer plan no longer satisfies the requirement of section 72(p)(2)(C) * * * [because] the participant fails to make a loan payment either on the date that it is due or within the allowed grace period." Duncan v. Commissioner, T.C. Memo. 2005-171, slip op. at 6; accord sec. 1.72(p)-1, Q&A-4 (explaining further that such a failure would result in a deemed distribution), Q&A-10(a) (providing that plan administrators may allow a cure (grace) period, which cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due, and that section 72(p)(2)(C) will not be considered to have been violated if the installment payment is made not later than the end of the cure period), Income Tax Regs. Where there is a failure to pay, the amount of the deemed distribution would equal the entire outstanding balance of the loan (including accrued interest) at the time of the failure. Sec. 1.72(p)-1, Q&A-10(b), Income Tax Regs.

Petitioners failed to make loan payments after May 2012, and they did not repay these missed amounts within the permitted cure period. They therefore do not meet the exception of section 72(p)(2), and the LAUSD QP loan balances are deemed taxable distributions as of November 2012, which is when NAMCO and Midland determined that the loans' grace periods had expired and, accordingly, that petitioner had defaulted. See Ryan v. Commissioner, T.C. Memo. 2011-139, slip op. at 17-18, aff'd, 482 F. App'x 881 (5th Cir. 2012); Owusu v. Commissioner, T.C. Memo. 2010-186, slip op. 9-10.

Petitioners' brief argues that the amounts of the QP deemed distributions cannot be both distributions and existing loan obligations--existing because NAMCO and Midland continued to send quarterly payment notices to petitioners even after the loans were determined defaulted on. It concludes that the statute is clear, that the QP complied with the statute, and, citing Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44 (2011), that the regulation is not entitled to any deference. We disagree.

Petitioners' brief ignores the first five words of the text of section 72(p)(2)(C): "[e]xcept as provided in regulations". These words plainly express Congress' intent to have subparagraph (C) clarified through appropriate regulations, and petitioners offer no alternative explanation for that choice of words. See Mayo Found, 562 U.S. at 45 ("Filling gaps in the Internal Revenue Code plainly requires the Treasury Department to make interpretive choices for statutory implementation[.]"). The regulations under section 72(p) establish the timing and amount of a deemed distribution, and this Court has heeded the final regulations for those determinations. See, e.g., Ryan v. Commissioner, T.C. Memo. 2011-139; Owusu v. Commissioner, T.C. Memo. 2010-186.

Petitioner had contracted to repay her QP loans under binding agreements--a completely separate (and irrelevant) issue from her having tax due because of deemed distributions from her QP. Cf. Egebjerg v. Anderson (In re Egebjerg), 574 F.3d 1045, 1049 (9th Cir. 2009) (explaining, within a bankruptcy context, that a retirement plan participant's loan from his retirement account "is essentially a debt to himself--he has borrowed his own money. [He] contributed the money to the account in the first place; should he fail to repay himself, the administrator has no personal recourse against him. Instead, the plan will deem the outstanding loan balance to be a distribution of funds, thereby reducing the amount available to * * * [the participant] from his account in the future." (Citations omitted.)).

Petitioners argue that there is no taxable income because the loan proceeds were used for a qualifying purpose. They assert that section 72(p)(2)(B)(ii) "waives the requirement that the loan be repaid with level amortization in five years if the loan is made in connection with acquiring a principal residence." They rely, somewhat ironically, on section 1.72(p)-1, Q&A-8, Income Tax Regs., for the premise that a plan loan does not have to be traced to the purchase of a principal residence so long as it is used to repay a loan that was obtained to purchase a residence. They conclude that there was no requirement for "level payments" and thus no deemed distributions could have occurred in 2012.

Petitioners misinterpret the Code. Section 72(p)(2)(B)(ii), which addresses an exception for home loans, applies only with respect to clause (i) of subparagraph (B), which addresses the requirement that a loan be repayable within five years. Clause (ii) allows for a loan period longer than five years when the loan is used for acquiring a principal residence; however, it has no bearing on the subparagraph (C) requirement of level amortization, which is still mandatory. Moreover, petitioner specifically affirmed in both loan agreements that the loans were not to be used as residential loans; hence they were made under a five-year repayment period.

Ultimately petitioners failed to repay the LAUSD QP loans, and they meet no exceptions under the Code or the related regulations. Therefore, respondent's determination to treat the loan balances as deemed distributions in 2012 is sustained.

Section 72(t) Additional Tax

Petitioners' brief alleges that respondent's attempt to impose a 10% "penalty", under section 72(q), for premature distributions from annuity contracts is inappropriate because "petitioners did not receive anything in 2012 upon which the penalty could be based." However, the notice of deficiency, upon which this case is based, determined a 10% additional tax under section 72(t)--not section 72(q).

A 10% tax on "early distributions", deemed or actual and occurring before the participant reaches the age 59½, generally applies where a taxpayer receives a QP distribution that is includible in her or his gross income. Sec. 72(t)(1) and (2). Although section 72(t)(2) sets forth certain exceptions to the 10% tax on early distributions, petitioners neither argue that they fit within any of these exceptions nor present evidence to suggest that they might. Therefore, we find that petitioners are liable for the 10% additional tax under section 72(t). See Roundy v. Commissioner, 122 F.3d 835, 837 (9th Cir. 1997), aff'g T.C. Memo. 1995-298.

Although petitioners refer to a "penalty", section 72(t)(1) provides for an "additional tax" and not a penalty. See generally El v. Commissioner, 144 T.C. 140, 146 (2015) (determining that the Commissioner has no initial burden of production with respect to the additional tax under section 72(t) because it is not a "penalty, addition to tax, or additional amount" under section 7491(c)).

Interest Income

Petitioners stipulated their receipt of $300 of interest income that was not reported on their 2012 return. See sec. 61(a)(4).

Cost of Current Life Insurance Protection

The cost of current life insurance protection provided by an employer is an economic benefit that is included, under section 61(a), in the gross income of the insured employee. See Cadwell v. Commissioner, 136 T.C. 38, 62 (2011), aff'd, 483 F. App'x 847 (4th Cir. 2012). The cost is included in the employee's gross income to allow the death benefit proceeds of the policy to pass to the employee's beneficiaries tax free. See secs. 1.61-22(f)(3)(i), (iii), 1.72-16(c)(4), Income Tax Regs.; see also sec. 101(a). Basically, the cost of current life insurance protection equals the amount of the current life insurance protection provided (typically the difference between the face amount of the policy and its cash surrender value) multiplied by a life insurance premium factor as permitted by IRS guidance. See sec. 1.61-22(d)(3), Income Tax Regs.

Petitioners argue that Conseco's cost of current life insurance protection computations, on which respondent relied for his determination, were "imprecise". They also argue that "respondent has not adequately established a methodology for the computation of any taxable income amount with respect to the life insurance."

As shown on its worksheets, Conseco calculated the cost by multiplying a premium rate of 1.29--acquired from "GOV TABLE 2001" and based upon petitioner's age of 43 at that time--to the difference between the face amount of the policy (termed "Death Benefit" on the worksheets) and its cash surrender value (termed "SURR VALUE"), then divided by 1,000 (because Table 2001, see supra, is based upon increments of $1,000 of life insurance protection). The de minimis "imprecision" of the calculation's resulting cost of $195.50--when compared to the reported cost of $195.68 on the Form 1099-R issued by Conseco--is explained in the worksheets as having occurred because the cash surrender value was available only up to December 24, 2012, at the time the worksheets were generated, and not up to December 31, 2012, which would have been the ending period used when calculating the amount shown on the 2012 Form 1099-R.

This "methodology" appears to follow the prescribed calculation, and petitioners offer no argument as to why it does not. It appears that Conseco appropriately used the IRS-provided Table 2001 to arrive at the correct premium rate, despite the worksheets' references to "PS-58" headings. (Premium factors provided by P.S. 58 rates, found in Rev. Rul. 55-747, 1955-2 C.B. 228, 229, have generally been supplanted by Table 2001, found in Notice 2001-10, 2001-1 C.B. 459, 463, or by an insurer's lower published premium rates that are available to all standard risks for initial issue one-year term insurance. See Notice 2002-8, 2002-1 C.B. 398, 399 (revoking Rev. Rul. 55-747, supra, except where, in certain circumstances, P.S. 58 rates may be used for life insurance arrangements entered into before January 28, 2002); see also sec. 1.61-22(d)(3)(ii), Income Tax Regs.) This Court has found that Table 2001 can be used to provide a reasonable estimate of the cost of one year of life insurance protection. See Cadwell v. Commissioner, 136 T.C. at 64. Accordingly, respondent's determination regarding the inclusion in income of the $195 cost of current life insurance protection for 2012 is sustained.

QTP Distribution

Petitioners' brief alleges that petitioner testified that all her contributions to the QTP were made with post-tax dollars and thus no distributions would be taxable. She did not so testify. Petitioners allege that they spent more than $1,300 in qualifying tuition, as supported by a statement from their daughter's college, which they presented for the first time at trial. The statement was not received into evidence because petitioners had failed to comply with the Court's standing pretrial order concerning exchange of documents. Their late production of the statement prejudiced respondent by precluding him from confirming whether the $162 QTP distribution actually was spent on items reflected on the statement.

Generally, a distribution from a QTP is includible in the distributee's gross income in the manner provided under section 72. Sec. 529(c)(3)(A). A taxpayer who receives a QTP distribution is subject to a 10% additional tax where the distributions were not used for educational expenses. Secs. 529(c)(6), 530(d)(4)(A). Because there is no reliable evidence showing that the $162 was used for eligible educational expenses, respondent's determination regarding the $162 QTP distribution is sustained. The additional 10% tax on a QTP distribution is also sustained.

Accuracy-Related Penalty

Section 6662(a) and (b)(2) imposes a 20% accuracy-related penalty on the portion of any underpayment of Federal income tax attributable to a taxpayer's substantial understatement of income tax. A substantial understatement of income tax exists if the understatement exceeds the greater of 10% of the tax required to be shown on the return or $5,000. Sec. 6662(d)(1)(A). Under section 7491(c) the Commissioner bears the burden of production with regard to penalties and must come forward with sufficient evidence indicating that it is appropriate to impose penalties. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the Commissioner has met the burden of production, the burden of proof remains with the taxpayer, including the burden of proving that the penalties are inappropriate because of reasonable cause or substantial authority. See Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.

Petitioners have an understatement of $8,320, which is more than $5,000 (which is greater than 10% of the $15,701 of tax that should have been reported on their 2012 return). Respondent has therefore met the burden of production as to the penalty, and petitioners must now show that the understatement, or any part thereof, is attributable to an item that was adequately disclosed and has a reasonable basis, or for which there was substantial authority for its tax treatment. See sec. 6662(d)(2)(B).

Although they were issued Forms 1099-R by NAMCO, Midland, and Conseco, petitioners neither disclosed on their 2012 tax return the taxable amounts reported on the Forms 1099-R nor explained why those amounts were not reported. See sec. 6662(d)(2)(B)(ii)(I); sec. 1.6662-4(e) and (f), Income Tax Regs. Petitioners allege that they did not receive any Forms 1099-R and that they had no reason to suspect that there was additional income to report for 2012. However, NAMCO, Midland, and Conseco sent their respective Forms 1099-R to petitioners' correct address. It is improbable that they did not receive any of the forms. See Tokarski v. Commissioner, 87 T.C. at 77. They also have not shown that any of the types of authority listed in section 1.6662-4(d)(3)(iii), Income Tax Regs., would support their failure to report the taxable amounts received, as shown on the Forms 1099-R, as income.

With regard to the QTP disbursement, petitioners knew that they withdrew money from a savings account that is not subject to Federal tax only because its funds are to be used for qualified education expenses. When they made the withdrawal in 2012--not shown to be used for educational expenses--they should have expected a tax consequence for that year, regardless of whether they subsequently received a Form 1099-R reporting the distribution. Cf. Brunsman v. Commissioner, T.C. Memo. 2003-291, slip op. at 5 (determining that the taxpayer did not need to receive a Form 1099-MISC to be alerted to the fact that he had received compensation).

Similarly, with respect to the deemed distributions, petitioners knew that they had stopped paying on the QP loans from tax-deferred accounts and, again, should have anticipated tax consequences. They suggest that their having continued to receive loan repayment notices should somehow excuse their actions--but the lending institutions' further attempts to recover the loan balances had no impact on the taxation of petitioners' deemed distributions in 2012. Ultimately, petitioners have shown no reasonable basis or substantial authority for their failure to report the income from these sources.

The accuracy-related penalty is not imposed with respect to any portion of the underpayment where the taxpayer acted with reasonable cause and in good faith. Sec. 6664(c)(1); see Higbee v. Commissioner, 116 T.C. at 448. Relevant factors with respect to whether a taxpayer acted with reasonable cause and in good faith include the taxpayer's knowledge and experience and her or his reliance on the advice of a professional, such as an accountant. See sec. 1.6664-4(b)(1), Income Tax Regs. Generally, however, the most important factor is the extent of the taxpayer's effort to determine her or his proper tax liability. Id.; accord Hansen v. Commissioner, 471 F.3d 1021, 1029 (9th Cir. 2006), aff'g T.C. Memo. 2004-269.

Petitioners argue that they suffered multiple calamities in 2012, including the death of petitioner's father, possible foreclosure on their personal residence, and, in 2014, their son's contracting cancer. While their hardships, financial and otherwise, may have understandably overshadowed their tax problems, those difficulties do not constitute reasonable cause for an underpayment of Federal income tax within the meaning of section 6664(c). Petitioner is an educated person, yet the facts and circumstances in this case indicate that petitioners did not attempt to assess their proper tax liability for 2012. Petitioners knew that they had received nonwage income, primarily from the out-of-the-ordinary sources of their QP and QTP, and they had a responsibility to determine whether and how those amounts should be reported. They exerted no effort to do so, and, accordingly, the section 6662(a) penalty is sustained.

We have considered the other arguments of the parties. They are moot, immaterial, or otherwise without merit. To reflect the foregoing,

Decision will be entered

for respondent.

T.C. Memo. 1992-392

UNITED STATES TAX COURT

WACHTELL, LIPTON, ROSEN & KATZ, DAVID M. EINHORN, TAX MATTERS PARTNER, Petitioner, v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14574-90

Filed July 14, 1992

For Petitioner: James P. Holden, Gerald A. Kafka, David M. Einhorn, and Warren R. Stern.

For Respondent: Catherine R. Chastanet, Theodore R. Leighton, Mark L. Hulse, Laurie B. Kazenoff, and Laurence D. Ziegler.

MEMORANDUM OPINION

CLAPP, Judge: This case is a partnership action for readjustment of partnership items under section 6226. Wachtell, Lipton, Rosen & Katz (Wachtell Lipton) is a general partnership engaged in the practice of law in New York City. On April 16, 1990, respondent issued a notice of final partnership administrative adjustment (FPAA) to disallow deductions of $7,062,204 claimed on the Wachtell Lipton partnership tax return for the year ended December 31, 1986. After concessions by the parties, the amount in dispute is $5,832,204.

The issue for decision is whether actuarial assumptions used by the enrolled actuary for the individual defined benefit plans (IDB plans) of Wachtell Lipton's partners to determine the plans' costs were reasonable in the aggregate and represented the actuary's best estimate of anticipated experience under the plans, as required by section 412(c)(3). Specifically, respondent determined: (1) The 5-percent preretirement and postretirement interest rate assumption used by the plans' actuary was unreasonably low; (2) the age 55 retirement assumption was unreasonably low; (3) the preretirement mortality assumption in a one person plan was unreasonable and, alternatively, the preretirement mortality assumption based upon the 1958 Commissioners' Standard Ordinary mortality table (1958 CSO mortality table) was unreasonable; and (4) the 7.5-percent preretirement and 5-percent and 7.5-percent postretirement expense load assumptions were unreasonable, and these assumptions were not offset by any other assumptions that would make the assumptions in the aggregate reasonable.

Preretirement Death Benefit

Each of the Wachtell Lipton IDB plans included insured benefits in the event of preretirement death. To provide for the death benefits, the plans purchased universal life insurance policies. The death benefit would no longer be provided after the plan participant reached retirement. Segal chose the envelope funding method to compute the premium costs for 36 of the plans and chose the premium paid method for 5 plans.

Section 1.412(c)(3)-1(f), Income Tax Regs., provides that the cost of certain "ancillary benefits" may be funded by a qualified pension plan. An "ancillary benefit" is defined as a benefit paid as a result of an event which occurs preretirement and which is "detrimental to the participant's health." Sec. 1.412(c)(3)-1(f)(2)(ii), Income Tax Regs. Death is deemed to be an event detrimental to a participant's health, see sec. 1.412(c)(3)-1(f)(2), Income Tax Regs.; thus, a preretirement death benefit such as that provided for in Wachtell Lipton IDB plans falls under the rubric "ancillary benefit".

The cost of an "ancillary benefit" may be computed "using the same method used to compute retirement benefit costs under a plan", sec. 1.412(c)(3)-1(f)(1), Income Tax Regs. ("envelope funding"), or "may equal the premium paid for that benefit under an insurance contract", sec. 1.412(c)(3)-1(f)(3), Income Tax Regs. ("premium paid method"). However, as discussed below, an amount equal to a reasonable net premium cost is not deductible under section 404(a)(8) and (e).

Preretirement Mortality

Respondent argued that it was unreasonable to assume preretirement mortality in a one person plan because the likelihood of that person's dying prior to retirement is negligible. According to respondent, such an assumption does not produce the "best estimate" of anticipated plan experience. While it is not entirely clear, it appears that respondent also argued that a preretirement mortality assumption was unnecessary because the death benefit was being provided through a life insurance policy and not by the plan. Respondent asserted "the actuary artificially increased the cost of the preretirement death benefit which was already funded through contributions and which would be satisfied from life insurance proceeds."

Respondent's expert Poulin supported the argument that there should be no preretirement mortality assumption in a one person plan. He characterized mortality in an IDB plan as an "either/or situation"; that is, the participant either dies before retirement or survives until retirement.

Respondent's first argument assumed that the probability of participant's preretirement death is at issue. It is not. As Wachtell Lipton points out, "the actuary's task is not to predict the likelihood of the participant's death; it is instead to compute plan costs." Segal did not establish the preretirement mortality assumption to predict accurately the incidence of preretirement mortality among the plans' participants, but rather used it as a means of estimating the cost of providing life insurance coverage for the preretirement death benefit. Establishment of a preretirement mortality assumption is a necessary step in estimating such a cost. Thus, the use of a preretirement mortality assumption was thus a reasonable method of funding the insured death benefit portion of the plans.

Respondent's second argument apparently assumed that use of a preretirement mortality assumption produces "double funding" of the death benefit. Respondent's assertion that the cost of the death benefit was already funded with benefit obligation contributions or would be satisfied from life insurance proceeds is unfounded. The purpose of establishing a preretirement mortality assumption is to determine the cost of the death benefit whether it is provided through the plan or by the purchase of life insurance. Either way, the plan must have the funds necessary to pay the cost. There is no double funding because no other assumption takes into account the cost of the insured death benefit.

Use of the 1958 CSO Mortality Table

Segal used the 1958 CSO mortality table to arrive at preretirement mortality assumptions; however, he funded the postretirement liabilities based on assumptions derived from the 1971 and 1983 individual annuity mortality tables (1971 IAM and 1983 IAM tables).

The 1958 CSO mortality table is used by insurance companies to estimate the mortality of purchasers of life insurance policies. The 1971 IAM and 1983 IAM tables are used by insurance companies to estimate the mortality of purchasers of annuities. These IAM tables predict a lower rate of deaths than does the 1958 CSO mortality table. There are three basic reasons for this disparity: (1) Human life expectancy improved after 1958; (2) actuarial experience dictates that purchasers of annuities live longer than purchasers of life insurance policies; and (3) insurers build margins for profit and conservatism into mortality tables to ensure solvency when benefits are claimed. This final consideration, commonly known as "loading" the mortality table, necessarily leads to opposite consequences in the sale of life insurance as compared to the sale of annuities. In the case of life insurance, insurers are prone to overestimate the chances of death, but when selling annuities, insurers will generally underestimate the chances of death, thus increasing available reserves for the required payouts under each kind of policy.

Respondent argued that Segal's use of the 1958 CSO mortality table was not reasonable in that it overstated the probability of each participant's death, unreasonably inflating each participant's tax-deductible plan contribution. In addition, respondent contended that the use of different types of mortality tables (CSO and IAM) for the same individual was unreasonable and overstated both pre and postretirement liabilities.

Respondent's expert Haneberg stated that he found it "troublesome from a professional standpoint" that an IAM table could be adopted for one purpose "while at the same time the plan's enrolled actuary is utilizing a table that predicts between two and three times as many deaths." Haneberg stated that the most accurate predictor of plan participants' preretirement mortality was neither the 1958 CSO mortality table nor the 1971 IAM table, but rather a mortality table developed in 1984 by the actuarial firm, Buck, which assumed fewer deaths at all relevant ages than even the 1971 IAM table.

Wachtell Lipton's expert Riebold concluded that it was reasonable for Segal to use the 1958 CSO mortality table to estimate the cost of the preretirement death benefit to the plans and the 1971 IAM and 1983 IAM tables for the postretirement mortality assumptions for those same plans. Because an insurance company would use a CSO-type table in its calculation of the premium cost for the preretirement death benefit and this premium would be a portion of the actual costs for the plan as a whole, Riebold contended that Segal was correct in having done the same. Concomitantly, reasoned Riebold, the postretirement benefit to be paid by the plan was in the nature of an annuity, and thus the appropriate table to be used in estimating mortality in that situation was an IAM-type table to ensure that sufficient reserves are available to fund the defined benefit during participant's retirement. Riebold stated: "it is not considered irregular to use a death benefit mortality table that is different from that used for the Maturity Values of the pension benefits. The determination of pre-retirement mortality involves considerations and objectives that differ from those involved in determining post-retirement mortality."

Wachtell Lipton's expert Joss testified that Segal's use of the 1958 CSO mortality table to estimate the cost of the preretirement death benefit was less expensive, and therefore more reasonable than other available funding options. The present value of a preretirement death benefit using an Allstate Insurance Company quote, and using the P.S. 58 rates estimated higher costs than those estimated under the 1958 CSO mortality table. Thus, Joss concluded that the use of the 1958 CSO mortality table to fund the death benefit, the least expensive of these three options, all of which were available to Segal, was reasonable.

While Haneberg and Poulin may be correct that the 1958 CSO mortality table overstates what the Wachtell Lipton plans' actual mortality experience will be, this has no bearing on the purpose of Segal's use of the 1958 CSO mortality table, which was not to measure accurately potential participant mortality, but was rather to estimate the life insurance premium expense to each of the plans. In addition, while the actual chances of any one of the participants dying before age 55 may be so low as to be negligible, as Poulin contended, the fact remains that, by definition, a preretirement death benefit assumes some possibility of preretirement death.

We believe that Segal was correct in choosing a CSO table to make his preretirement mortality assumptions, as this was the same type of table which would be used by an insurance company in computing the premium it would charge to the plans. While there was a more recent CSO table available to Segal, the 1980 CSO table, which used more current life expectancy figures, it was not contended by respondent's experts that Segal should have used this newer table. In fact, Haneberg, while testifying before the Court, acknowledged that to make a reasonable mortality assumption, one need not use the most recent table available.

A mortality table should be used only for the purpose which it is meant to fulfill. A preretirement death benefit has different requirements than does a postretirement annuity. In the case of the former, there must be reserves available if the beneficiary dies unexpectedly soon, and in the case of the latter, there must be reserves available if the beneficiary lives unexpectedly long. What is important is that when the plan participant or his beneficiary requires the funds to be disbursed, they be available. The dual mortality table method devised by Segal legitimately fulfills the funding needs of both a preretirement death benefit and a postretirement annuity.

We hold that Segal's use of the 1958 CSO mortality table as a preretirement mortality assumption for the Wachtell Lipton plans providing a preretirement death benefit was reasonable.

Deductibility of the Death Benefit Contributions

The universal life insurance purchased by Wachtell Lipton's plans provided for annual term life insurance and an additional cash surrender or cash value portion. The contracts were structured to allocate contributions funding the plans' death benefits between the annual term life insurance premium and the cash value portion. This latter portion, described by Wachtell Lipton's expert Riebold as an "individual level premium reserve portion", is a fund which was structured initially to increase due to allocations from the death benefit contributions, and then to decrease in the future as contributions cease and the fund and earnings on the fund were to be used to pay for the remaining term life insurance coverage.

Under section 404(a)(8) and (e), the portion of the contribution allocable to the purchase of life insurance is not deductible. Section 1.404(e)-1A(g), Income Tax Regs., provides as follows:

(g) Contributions allocable to insurance protection. Under section 404(e)(3), for purposes of determining the amount deductible with respect to contributions on behalf of a self-employed individual, amounts allocable to the purchase of life, accident, health, or other insurance protection shall not be taken into account. Such amounts are neither deductible nor considered as contributions for purposes of determining the maximum amount of contributions that may be made on behalf of an owner-employee. The amount of a contribution allocable to insurance shall be an amount equal to a reasonable net premium cost, as determined by the Commissioner, for such amount of insurance for the appropriate period. See paragraph (b)(5) of section 1.72-16.

Therefore, only the premium attributable to the cash value portion of the universal life policy is deductible; the premium attributable to the term life portion of the policy is not deductible. Wachtell Lipton agreed that death benefit contributions attributable to a reasonable net premium cost are not deductible, and has conceded $111,094 in this regard. Apparently, respondent agreed that "in the case of defined benefit plans owning universal life insurance products, the effect of section 404(e) is to deny a deduction only for the net premium cost of the benefit as set forth in [Income Tax] Reg. sec. 1.404(e)-1A(g)." However, because of the structure of the life insurance policies purchased by the Wachtell Lipton IDB plans, respondent argued that even the cash value portion of the insurance premiums were not deductible. Respondent asserted that any part of the cash value portion eventually used to pay the cost of insurance coverage is nondeductible under the section 404(a)(8) and (e) prohibition. We disagree.

The future use of death benefit contributions allocable to the cash value portion does not affect its otherwise current deductibility. To the extent that any such portion is used to pay future term life insurance premiums, that amount is includable in the income of the participant in that year. Such use of the cash value portion is equivalent to a personal expenditure on a nondeductible item (in this case, term life insurance) in a future year. This treatment is consistent with the treatment of future benefit distributions which are taxed upon distribution, with after-tax dollars expended in any way the participant desires.

The critical computation is the determination of an amount equal to a "reasonable net premium cost" under sections 1.404(e)-1A(g) and 1.72-16(b)(5), Income Tax Regs. Since we have dismissed respondent's arguments regarding the probability of death in an IDB plan, Segal's use of the 1958 CSO mortality table, and the current deductibility of otherwise deductible death benefit contributions, this is the only remaining issue.

Respondent argues that section 1.72-16(b)(5), Income Tax Regs., is not controlling despite the express reference to it by section 1.404(e)-1A(g), Income Tax Regs., because it was aimed at the situation of an employer providing insurance coverage through a "group policy". Respondent cites no authority for this proposition, and the argument fails. As section 1.72-16(b)(5), Income Tax Regs., makes clear, the term "reasonable net premium cost" refers to the reasonable premium cost of an amount of insurance less any cash value inherent in the policy. Nothing in that section indicates that its scope was intended to be restricted to any particular type of insurance policy, defined benefit pension plan, plan sponsor, or participant.

We hold that Wachtell Lipton's death benefit contributions calculated using the 1958 CSO mortality table to estimate preretirement mortality for the year at issue were properly deductible to the extent that they exceed a reasonable net premium cost of providing life insurance for that period within the meaning of sections 1.404(e)-1A(g) and 1.72-16(b)(5), Income Tax Regs. We leave that calculation to the parties under Rule 155.

Private Letter Ruling

Number: 7902083

Internal Revenue Service

October 16, 1978

Symbol: E:EP:T:3

This is in response to your recent ruling request submitted to this office on September 11, 1978.

In your request, you state that you were a participant in a qualified, noncontributory profit-sharing plan. Although you made no direct employee contributions, you were taxed on amounts representing the current value of the life insurance protection provided by the plan (i.e., PS-58 costs). On September 7, 1978, pursuant to the plan, you received a lump-sum distribution of $63,546.78 representing the total of the cash surrender value of the life insurance contracts plus your profit-sharing account balance. You hope to rollover these amounts to a qualified individual retirement account (IRA).

Based on these facts and circumstances you request a ruling that amounts attributable to PS-58 costs are not to be considered employee contributions such that an amount equivalent to those costs need not be deducted from the rollover amount.

Analysis:

Section 402(a)(5) of the Internal Revenue Code provides various requirements for tax-free rollovers of lump-sum distributions. This section provides for favorable tax treatment of lump-sum distributions provided that the entire amount to the credit of an employee is paid to him within one taxable year of the employee, and provided that all such amounts, to the extent they exceed the employee's basis in such property, are rolled over on or before the sixtieth day after the day the employee received such property.

Section 402(c)(4) further defines a lump-sum distribution and clearly states that amounts attributable to employee contributions within the meaning of section 72(f) must not be rolled over. Section 72(f) and the regulations thereunder provide that amounts contributed by the employer but includible in the employee's gross income are to be considered the employee's contributions. Since PS-58 costs, are, per section 72(m)(3), taxable to the employee, they would be considered employee contributions within the meaning of section 72(f).

The regulations under section 1.72-16(b)(4) provide, however, that amounts includible in the employees' income shall be considered employee contributions only with respect to the actual contract (within the meaning of 1.72-2(a)(3)) providing life insurance protection. Section 1.72-2(a)(3) states that all separate programs of an employer consisting of interrelated contributions and benefits shall be considered a single contract. Further, retirement benefits and life insurance will be considered single contracts to the extent that the benefits are provided by retirement insurance, endowment, or other contracts providing life insurance protection.

Revenue Ruling 67-336, (1967-2 C.B. 66) provided further clarification of these provisions. That ruling states that the employee contributions will include PS-58 costs only if the same contract is distributed to the employee. In that ruling, as in this instance, the trustees surrendered a life insurance policy on which the employee had previously been taxed. Whether the surrender value of the life insurance contract is used to provide a new annuity contract (as in Revenue Ruling 67-336) or to provide part of a lump-sum cash disbursement which contains no life insurance element (as in the instant case), the employee carries over no basis in these PS-58 costs since the actual contract on which he was originally taxed is not included in the distribution.

Therefore, based on the facts and circumstances described above, we conclude that the amount of the PS-58 costs previously taxed to you are not to be considered employee contributions within the meaning of section 402(e)(4)(B)(i) and, thus, must be rolled over within the requirements of 402(a)(5).

Additional Information:

Regarding the proper taxability of amounts received by your spouse, it should be noted that sections 408(a)(6) (with respect to individual retirement accounts) and 408(b)(3) (with respect to individual retirement annuities) provide for distributions to the participant over a period based on the joint life expectancies of the participant and his spouse or a term certain not to exceed such life expectancies. If such a distribution has commenced prior to the participant's death, distribution may continue in this manner. Section 2039(e) of the Code, added by the Tax Reform Act of 1976, provides that such amounts are excludible from the decedent's estate provided that distributions are made in substantially equal periodic payments over the beneficiary's life or for a period of at least 36 months after the death of the participant.

With respect to your final question, nothing in the Code or regulations requires you to notify the trustees of your rollover transactions.

Written Determination

Number: 7922109

Internal Revenue Service

March 5, 1979

Symbol: E:EP:T:2

This is in response to your ruling request submitted on behalf of M Corporation regarding certain Federal income tax consequences of mandatory participant contributions and the application of those contributions to the cost of incidental life insurance protection under Plan X.

M Corporation maintains Plan X, a contributory defined benefit pension plan qualified under section 401(a) of the Internal Revenue Code and tax exempt under Code section 501(a). Plan X provides for the purchase of an ordinary life insurance policy with an annuity option for each plan participant. Plan X also provides that an employee's contributions are first applied to the cost of life insurance protection. Regarding distributions of benefits, section 8.1 of Plan X provides that upon retirement of a participant, the trustees will utilize Plan X trust assets to pay any additional premiums required to exercise the annuity option of the policy. Section 8.1 of Plan X also provides that benefits may be paid directly from the trust and/or through the purchase of annuity policies from insurers other than the company issuing the life insurance policy theretofore providing death benefits for the participant, in which case the trustees shall surrender for cash value all or the appropriate part of such policies.

Among the optional forms of benefit distribution under Plan X, a participant may elect to receive his retirement or disability benefits in a single sum, pursuant to section 8.2 of the plan. If a participant dies prior to retirement, his beneficiaries receive the death benefit payable under the life insurance policies purchased for the benefit of the participant.

Section 5.8 of Plan X, which relates to mandatory employee contributions, states that:

"Each participant shall be required to contribute to the plan, for each month during which he is an active participant, an amount equal to $1.00 for each $10.00 of projected monthly retirement benefit computed pursuant to section 6.1. The contributions of each participant shall be first applied to payment of the portion of the premiums on the policies, if any, on his life which is considered as the cost of insurance protection to the participant. The company shall advance the annual amount of the contributions of each participant to the trustees, and, except as otherwise determined by the company, the company shall recover such advances through regular payroll deductions."

Based on the foregoing, the following rulings are requested:

Ruling Request 1. By virtue of the provision in section 5.8 of Plan X, to the effect that: "The contributions of each participant shall be first applied to payment of the portion of the premiums on the policies, if any, on his life which is considered as the cost of life insurance protection to the participant," the annual cost of life insurance protection shall not be includable in the gross income of any employee who participates in Plan X, except to the extent that the cost of life insurance protection, in any taxable year of the employee, exceeds the sum of his contributions made to Plan X during such year plus the excess of (i) his contributions to Plan X in all prior years over (ii) the cumulative cost of life insurance protection chargeable to him in all prior years.

For purposes of your second and third ruling requests, you have provided the following illustrative situation:

Employees A and B are about to retire, and each has elected that the total value of his benefits be paid to him in one lump sum, which he intends to transfer into an individual retirement account (IRA) in accordance with section 402(a)(5) of the Code. Employee A's contributions to Plan X have each year exceeded the annual cost of life insurance protection chargeable to him. Employee B's contributions to Plan X have each year been exceeded by the annual cost of life insurance protection chargeable to him. In neither case have there been any withdrawals of contributions by the employees.

Ruling Request 2. The amount which employee A must roll over into an individual retirement account, pursuant to section 402(a)(5) of the Code, in order to avoid inclusion in his gross income of the distribution he receives from Plan X, assuming such distribution constitutes a lump-sum distribution within the meaning of section 402(e)(4)(A) of the Code, is the total amount of the distribution less the dollar amount of his contributions to Plan X.

Ruling Request 3. Assuming that employee B receives, as part of his distribution from Plan X, the life insurance contract or contracts which provided protection to him during his tenure as a participant, the amount which employee B must roll over into an individual retirement account, pursuant to section 402(a)(5) of the Code, in order to avoid inclusion in his gross income of the distribution he receives from Plan X, assuming such distribution constitutes a lump-sum distribution within the meaning of section 402(e)(4)(A) of the Code, is the total amount of the distribution less the sum of (i) the dollar amount of his contributions to Plan X plus (ii) the additional amounts previously taxed to him as the cost of life insurance protection. Assuming, on the other hand, that prior to the distribution the life insurance contract or contracts were surrendered for cash value by the trustees, the amount to be rolled over is the total amount of the distribution less the dollar amount of employee B's contributions to Plan X.

Your fourth ruling request is based on the following situation:

Employee C is about to retire and will receive his retirement benefits from Plan X in monthly annuity payments, in a fixed number of installments, or in a single lump-sum, but no rollover to an individual retirement account is contemplated. Employee C's contributions to Plan X have each year exceeded the annual cost of life insurance protection chargeable to him. He has not previously withdrawn any of his contributions.

Ruling Request 4. The amount which employee C must include in his gross income upon receipt of benefits from Plan X shall be reduced, pursuant to section 72 or section 402, as the case may be, by the full amount of his contributions to Plan X, notwithstanding the fact that any portion of those contributions was applied to the cost of life insurance protection.

Your fifth ruling request is based on the following situation:

Employee D has died, as a result of which the proceeds from the life insurance policies on his life will be paid to his beneficiary. During D's lifetime, his contributions to Plan X each year exceeded the annual cost of life insurance protection chargeable to him.

Ruling Request 5. The amount of death benefits which the beneficiary of employee D must include in gross income upon receipt of the death benefits from Plan X, after the application of the exclusion based upon section 101 of the Code, shall be reduced, pursuant to section 72 or section 402 of the Code, as the case may be, by the full amount of employee D's contributions to Plan X, notwithstanding the fact that any portion of those contributions was applied to the cost of life insurance protection during employee D's lifetime.

Revenue Ruling 68-390, 1968-2 C.B. 175, states that the net term cost of life insurance protection purchased under a qualified plan which does not specify whether employer or employee contributions are to be used to purchase the insurance protection will be considered to have been paid first from employer contributions and trust income and, therefore, will be includable in the gross income of the employees in the taxable year when so applied.

However, Plan X provides that employee contributions are first applied to the cost of life insurance protection. Therefore, we conclude, with respect to your first ruling request, that the annual cost of life insurance protection under Plan X is not includable in the gross income of a participant, except to the extent that the cost of life insurance protection, in any taxable year of the employee, exceeds the sum of his contributions made to Plan X during such year plus the excess of (i) his contributions to Plan X in all prior years over (ii) the cumulative cost of life insurance protection chargeable to him in all prior years.

Code section 402(a)(1) states that the amount actually distributed or made available to any distributee by a qualified employees' trust shall be taxable to him in the year in which so distributed or made available, under section 72 (relating to annuities).

Code section 402(a)(5) provides, in general, that if (1) the balance to the credit of an employee is paid to him from a qualified employees' trust, within one taxable year of the employee in one or more distributions which constitute a lump-sum distribution within the meaning of section 402(e)(4)(A) and, (2) the employee transfers all or any part of the distribution to an IRA within 60 days after the day on which he received the distribution, then (3) to the extent so transferred, such distribution is not includable in the employee's gross income for the taxable year in which paid.

Code section 402(a)(5)(B) states that in determining the maximum amount which may be rolled over, the fair market value of all the property the employee receives in the distribution shall be reduced by the employee's contributions. The definition of employee contributions, as provided by Code section 402(D)(ii) [sic], is the excess of the amounts considered contributed by the employee (determined by applying section 72(f)), over any amounts theretofore distributed to the employee which were not includable in gross income.

With respect to computing the aggregate premiums or other consideration paid, Code section 72(f) states, in part, that amounts contributed by the employer shall be included, but only to the extent that such amounts were includable in the gross income of the employee. However, section 1.72-16(b)(4) of the Income Tax Regulations, dealing with the treatment of the cost of life insurance protection, provides that the amounts includable in the gross income of the employee under this paragraph shall be considered as premiums or other consideration paid or contributed by the employee only with respect to any benefits attributable to the contract (within the meaning of paragraph (a)(3) of section 1.72-2) providing the life insurance protection. No distinction is made as to whether the amounts thus includable in gross income are attributable to employee contributions, employer contributions, or trust earnings.

Revenue Ruling 67-336, 1967-2 C.B. 66, provides that where the trustee of an employees' trust surrendered a life insurance contract and used the proceeds plus additional monies from the plan investment account to purchase the annuity contract, the employee's consideration for the annuity contract did not include premiums paid for the current life insurance protection provided under the insurance contract that were included in the employee's gross income.

The present position of the Service is that where a life insurance policy held under a qualified plan is surrendered and the cash surrender value is distrbuted [sic] to the employee as part of lump-sum distribution or otherwise, the employee has no basis in the amount applied to premium costs and included in the employee's income because the actual contract under which amounts were so applied is not included in the distribution. Again, no distinction is made as to whether the amounts thus applied are attributable to employee contributions, employer contributions, or earnings. On the other hand, if the actual life insurance contract which provided protection to the employee while he was a plan participant is distributed to the employee, the employee's basis in the distribution includes employee or employer contributions and trusts earnings which were applied to premium costs of that contract and which were previously included in the employee's income.

Accordingly, we conclude, with respect to your second ruling request, that the amount which employee A must roll over into an IRA, pursuant to Code section 402(a)(5), in order to avoid inclusion in his gross income of the distribution he receives from Plan X, assuming such distribution constitutes a lump-sum distribution within the meaning of section 402(e)(4)(A) of the Code, is the total amount of the distribution, less any employee contributions which were not applied to the cost of life insurance protection under Plan X.

Our conclusion with respect to your third ruling request is that if employee B receives, as part of a lump-sum distribution from Plan X, the life insurance contract or contracts which provided protection to him while he was a Plan X participant, the amount which he must roll over to an IRA, pursuant to Code section 402(a)(5), is any portion of the total amount of the distribution less the sum of (i) the dollar amount of his contribution to Plan X, plus (ii) the additional amounts previously taxed to him as the costs of life insurance protection. To the extent that a portion of such total taxable amount is rolled over to an IRA, such portion is not includable in the employee's gross income until paid or distributed from the IRA.

We further conclude, however, that if such life insurance contract or contracts are surrendered for their cash value by the trustees and distributed to employee B as part of a lump-sum distribution or otherwise, employee B's basis in the distribution is equal to employee contributions not applied toward the cost of life insurance protection. In this case, the amount employee B may roll over to an IRA, pursuant to Code section 402(a)(5) is any portion of the total amount of such distribution less the dollar amount of his contributions to Plan X which were not applied toward the purchase of life insurance protection.

Code section 72(a) states that except as otherwise provided, gross income includes any amount received as an annuity, endowment, or life insurance contract. However, gross income does not include that part of any amount received as an annuity under an annuity, endowment, or lifife [sic] insurance contract which is attributable to the employee's investment in the contract.

Regarding the receipt of a lump-sum distribution, Code section 402(e)(4)(D) excludes employee contributions from the definition of total taxable amount of such a distribution. However, employee contributions which are applied to the cost of life insurance protection under a plan lose their character as employee contributions upon distribution from the plan in either lump-sum or annuity form.

Accordingly, we conclude, with respect to your fourth ruling request that the amount which employee C must include in his gross income upon receipt of benefits from Plan X shall be reduced, pursuant to section 72 or section 402 of the Code, as the case may be, by the amount of his contributions to Plan X, which were not applied to the cost of life insurance protection.

Under regulations section 1.402(a)-1(a)(5), if pension or annuity payments or other benefits are paid or made available to the beneficiary of a deceased employee or a deceased retired employee from a qualified and tax exempt employee's trust, such amounts are taxable in accordance with the rules of section 402(a) and section 72 of the Code. Regulations section 1.72-16(c) provides that when an amount is payable, by reason of the death of the employee, from a life insurance policy held under a qualified plan, and the employee either paid the cost of the insurance or was taxed on the cost of the insurance, Code section 101 applies to exclude from gross income the excess of the policy proceeds over the policy cash value. However, this applies only where the policy itself is distributed.

Accordingly, we conclude, with respect to your fifth ruling request, that the amount of death benefits which the beneficiary of employee D must include in his gross income upon receipt of the death benefits from Plan X, after application of the exclusion based upon section 101 of the Code, shall be reduced, pursuant to section 72 or section 402 of the Code, as the case may be, by the amount of employee D's contributions to Plan X, which were not applied to the cost of life insurance protection during employee D's lifetime.

These rulings are based on the assumption that Plan X will remain qualified and tax exempt under Code sections 401(a) and 501(a) at the time of such distributions.

Written Determination

Number: 8003039

Internal Revenue Service

October 24, 1979

In a letter dated August 31, 1979, Company M's authorized representative requested a ruling as to the current income tax consequences to a participant in Plan X of death benefits payable under the terms of Plan X.

Corporation M established Plan X, a defined benefit pension plan, effective May 1, 1976, and was issued a favorable determination letter by the appropriate District Director on April 30, 1978.

Corporation M proposes to amend Plan X to permit the trustee to reinsure the plan liability for death benefits for participants.

The proposed amendment provides for a death benefit for each participating employee in an amount equal to 100 times the employee's anticipated monthly retirement income under Plan X. The death benefits are to be paid from the general assets of the trust. However, if the Plan X committee determines that it is in the best interest of the plan, it may direct the trustee to purchase insurance on the life of a participant to insure a portion or all of the trust's potential liability for death benefits for a particular participant. The trustee will be the owner and the trust will be the beneficiary of all the policies.

Under the proposed amendment, the trustee must commingle any death proceeds from insurance policies with the general assets of the trust fund to be invested and reinvested in accordance with the terms of the trust. The deceased participant's death benefit will then be paid from the general assets of the trust to the participant's surviving spouse over a period of not less than three years following death.

The Plan committee of Plan X proposes to direct the trustee to reinsure a portion of the plan death benefit liability on the lives of certain participants. The trust will bear the liability for the death benefits on other participants without reinsurance.

Ruling Request 1:

The includability in a participant's gross income of the cost of the current term insurance provided under an insurance policy on a participant's life which is purchased by the trust.

Analysis:

Section 72(m)(3) of the Code and section 1.72-16(b) of the Income Tax Regulations provide, generally, that the current cost of life insurance protection purchased under a qualified plan is includible in the gross income of an employee if the proceeds of the life insurance contract are payable directly or indirectly to the employee or his beneficiary.

Section 1.72-16(b)(6) of the Regulations, however, provides that section 1.72-16(b) does not apply in situations where the trust has a right under any circumstances to retain any part of the proceeds of the life insurance contract. This section further provides that section 1.72-16(c)(4) will determine taxability of the distribution of proceeds to a beneficiary.

Section 1.72-16(c)(4) of the Regulations provides that, where an employee has neither paid the total cost of life insurance protection provided under a life insurance contract nor was taxed under section 1.72-16(b), no part of the proceeds from the contract can be excluded under section 101(a) of the Code by the beneficiaries of the employee. Additionally, the entire distribution will be taxable to the beneficiaries under section 402(a) or 403(a), except to the extent that a limited exclusion may be allowable under section 101(b).

Revenue Ruling 66-138, 1966-1 C.B. 25, in dealing with the taxability to participants of a group assurance indemnity policy purchased by a qualified plan stated:

".... under the contract of assurance the owner of the policy is the trust. Any and all proceeds payable at any time under the policy are payable only to and receivable by the trust. Neither title to nor interest in any such contract or policy of assurance can vest in any beneficiary or member under the plan or trust. Since all proceeds are commingled with other assets of the trust no beneficiary can be considered as having received any portion of the proceeds under the assurance policy.

In view of all of the foregoing, the premiums paid for the group assurance indemnity policy do not constitute taxable income to the employee participants in the plan and trust."

Except for the fact that in the present case we are dealing with individual contracts on individual lives, we find here a case very similar to the one considered in Rev. Rul. 66-138. Therefore, as to ruling request 1, we conclude that since a participant will have no interest in the life insurance contract on his life purchased by Plan X in order to provide a source of funds with which to pay plan benefits he will incur no current income tax liability with respect to the cost of the current term insurance protection provided under such contract.

Ruling Request 2:

Whether the death benefit paid to a deceased participant's beneficiary will qualify for the exclusion of life insurance proceeds in computing the beneficiary's gross income, as provided for under Internal Revenue Code section 101(a).

Section 402(a)(1) of the Code provides, in part, that the amount actually distributed or made available to any distributee by an employees' trust described in section 401(a), which is exempt from tax under section 501(a), shall be taxable to him in the year in which so distributed or made available, in accordance with the rules of section 72 of the Code (relating to annuities).

We conclude, as to ruling request 2, that death benefits received from Plan X by a deceased participant's beneficiary will be includible in income in the year distributed or made available under section 402(a)(1) of the Code, and will not qualify for the exclusion of life insurance proceeds provided by Code section 101(a).

Written Determination

Number: 8125016

Internal Revenue Service

March 24, 1981

Symbol: E:EP:T:2

Uniform Issue List No.: 0402.00-00

Corporation M = * * *

Corporation N = * * *

Corporation O = * * *

Plan X = * * *

Plan Y = * * *

Plan Z = * * *

Gentlemen:

In a letter dated August 13, 1980, as supplemented by subsequent letters, your authorized representative requested rulings on your behalf concerning the federal income tax consequences to participating employees of the distribution options available to them in conjunction with the termination of Plan X.

The individuals who participate in Plan X are employees of the sponsoring employers: Corporations M, N and O. Plan X is a trusteed defined benefit pension plan established effective July 1, 1949, for employees of Corporations M, N and O. Effective July 1, 1976, Plan X was amended to comply with requirements of the Employee Retirement Income Security Act of 1974 (ERISA). A favorable determination of Plan X's continued qualification as amended was issued by the appropriate District Director on February 25, 1977. Effective July 1, 1978, additional amendments were made to bring Plan X into compliance with final regulations. A request for determination of Plan X's continued qualification, as amended, was filed on June 25, 1979, with the appropriate District office under the Special Reliance Procedure. The application has been reviewed and agreement has been reached with respect to additional amendments to be made, but the determination letter has not yet been issued.

On March 14, 1980, Corporations M, N and O acted to terminate Plan X. A Notice of Intent to Terminate was filed with the Pension Benefit Guaranty Corporation (PBGC) on May 21, 1980. The PBGC tentatively established June 30, 1980, as the plan termination date. In a telephone conversation on September 12, 1980, between a member of this office and your authorized representative, we were told that the Notice of Sufficiency has been issued. A request for determination of the continued qualification of Plan X upon termination was filed with the appropriate District office on June 4, 1980. Additional information was requested by the reviewing office and has been provided. The determination letter on the Plan X termination has not yet been issued.

Effective July 1, 1980, Corporations M, N and O are adopting Plan Y, a multiple employer, defined benefit pension plan.

Plan X has been funded exclusively by the purchase of individual endowment and retirement income contracts satisfying the requirements of Internal Revenue Code section 412(i). Under the terms of Plan X, the accrued benefit of each participant at any date prior to normal retirement age is equal to the cash surrender value of the insurance contracts purchased on behalf of the participant for purposes of providing retirement benefits under Plan X. Plan X is funded by employer and mandatory employee contributions.

In conjunction with the Plan X termination, participants will be offered three options with respect to distribution of their vested accrued benefits:

(i) Single sum cash distributions,

(ii) Transfer of all or part of their accrued benefit to Plan Z, or

(iii) Assignment of insurance contracts to the participants.

The election is to be made in writing on a form provided by the Plan X administrator and will be irrevocable once made. No distribution is to be made to any participant until a Notice of Sufficiency has been issued by PBGC, a determination of Plan X's continued qualification has been issued by the District Director, and the participant has completed an election form and filed it with the Plan X administrator. Amounts transferred to Plan Z will be distributable at a future time (death, disability, retirement, other termination of employment, or withdrawal) under the distribution and withdrawal provisions of Plan Z.

Effective July 1, 1980, employers maintaining the terminated Plan X will adopt Plan Y, a master or prototype defined benefit pension plan. Effective July 1, 1980, participants in the terminating Plan X will be participants accruing benefits under Plan Y.

Participants in the terminating Plan X also participate in Plan Z, a thrift plan to which only employee contributions are made. Plan Z has been determined by the District Director to be a qualified plan. Determination letters were issued on the plan October 31, 1978, and April 10, 1979.

Plan X provides that dividends payable on insurance contracts are to be paid to the trustee to be held in a general fund and applied to reduce the subsequent year's premiums. Since Plan X has been terminated, no premiums will be payable next year. It is proposed that Plan X be amended to provide that dividends payable after the date of termination be allocated directly to each contract on which dividends are payable, thus increasing the cash surrender value and termination distributions payable to the participants.

All contracts that fund Plan X benefits carry special endorsements providing the contracts are nontransferable if they are distributed to a plan participant. All contracts contain a life insurance element in the form of a pre-retirement death benefit.

Many Plan X participants have satisfied the age and service requirements for early retirement under Plan X. Some of these participants are proposing to take their termination distributions by electing to have the retirement income and endowment policies purchased to fund their benefits under Plan X assigned to them for the purpose of electing immediate commencement of annuity payments under any one of the settlement options available under the contracts. Under the terms of the contracts, election of current payment under any one of the settlement options would terminate the life insurance protection provided in the form of a pre-retirement death benefit equal to the face amount of the contract. The amount payable under any of the settlement options is determined by the cash surrender value of the contracts and the annuity purchase rates specified in the contracts at the time payment commences.

Plan Z has been determined by the appropriate Key District to be a qualified plan under Code section 401(a). Determination letters were issued to sponsoring employers on October 31, 1978, and April 10, 1979. Corporation O, a sponsoring employer of the terminating Plan X, is also a sponsoring employer in Plan Z and received a determination letter issued April 10, 1978. Both Plan X and Plan Z are to be amended to permit participants to direct the trustee to transfer all or part of their interest in Plan X to Plan Z where it will be held in a separate account in the name of the participant.

In accordance with the foregoing, rulings are requested as follows:

1. Participants entitled to termination distributions will not be deemed in constructive receipt of their interests in Plan X merely because each participant is allowed to make an irrevocable election among several distribution options one of which is a single payment in cash.

2. Termination distributions made as single cash payments will be qualifying rollover distributions within the meaning of Code section 402(a)(5)(D)(i)(I).

3. Under the aggregation rules of Code section 402(e)(4)(C), Plan Y and Plan X will be considered a single plan for purposes of determining whether termination distributions are lump sum distributions within the meaning of Code section 402(e)(4)(A).

4. Under the aggregation rules of Code section 402(e)(4)(C), Plan Z and Plan X will not be considered a single plan for purposes of determining whether termination distributions are lump sum distributions within the meaning of Code section 402(e)(4)(A).

5. Allocation of dividends payable after Plan X terminates to the contracts on which the dividends are payable will not violate the requirement that plan benefits be definitely determinable and will satisfy the requirement of Income Tax Regulations section 1.401-6(a)(2) that a terminating plan provide for the allocation of any previously unallocated funds.

6. A participant electing to take his termination distributions in the form of assignment of the retirement income and endowment contracts purchased to fund his benefits under Plan X will be deemed to have converted such contracts into nontransferable annuity contracts under which no part of any proceeds payable on death would be excludable from income under Code section 101(a), if within 60 days of receiving the contracts he elects to begin receiving benefits under the contracts immediately under any of the settlement options available under the contracts.

7. P.S.-58 costs that were taxable as income to the participant will be considered employee contributions for purposes of applying the Code section 72 employee contribution recovery rules to payments made under the contracts to participants who elect to take termination distribution in the form of assignment of the endowment and retirement income contracts purchased to fund their Plan X benefits and elect to have the payment of benefits commence immediately under the settlement options available under such contracts.

8. If a participant makes an individual retirement account (IRA) rollover contribution or elects to transfer to Plan Z an amount less than his total interest in Plan X, the amount not rolled over or transferred and distributed to him in cash will be includible in taxable income only to the extent it exceeds the amount of the employee contributions made by the participant to Plan X.

9. For purposes of computing the amount of a termination distribution that is excludable from income as a return of employee contributions under Code section 72, retirement income or endowment contracts assigned to the participant may be deemed to be a return of employee contributions in the amount of their cash surrender value that is not in excess of the contributions made by the participant to Plan X.

10. For purposes of computing the portion of a termination distribution that is excludable as a return of employee contributions, the P.S.-58 costs the participant reported as income on any contract actually assigned to the participant will be considered recoverable employee contributions whether the participant elects an immediate payout under one of the settlement options, or takes assignment of contracts as a nontaxable return of employee contributions to the extent of their cash surrender value and holds the contracts until they mature.

11. Election by a participant to have all or part of his interest in Plan X transferred by the trustee to Plan Z will not cause the amounts transferred to be considered made available or distributed to the participant.

12. Employee as well as employer contributions may be transferred to Plan Z without regard to the 10 percent limit on voluntary employee contributions, and transferred amounts will be considered rollover amounts within the meaning of Code section 415(c)(2).

With regard to ruling request 1, section 402(a)(1) of the Code states, in part, that the amount actually distributed or made available to any distributee by an employees' trust described in section 401(a), which is exempt from tax under section 501(a), shall be taxable to him in the year in which so distributed or made available. Therefore, under section 402(a)(1) of the Code, in some circumstances a participant in a qualified plan will be subjected to tax on his interest in a trust in a year even if such interest is not actually distributed to him in that year, if his interest is made available to him.

Revenue Ruling 55-317, 1955-1 C.B. 329, defines the term "made available." Rev. Rul. 55-317 states, in part, that an amount which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart although not then actually reduced to possession. To be made available, the amount must be credited to or set apart for the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and must be made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition.

Rev. Rul. 55-423, 1955-1 C.B. 41, provides examples of two classes of substantial conditions on an amount payable to a plan participant. The two general classes are penalties for withdrawal and the requirement that a prior irrevocable election be made to defer distribution to a fixed or determinable future time.

In a deferment by prior election, if the trust indenture or the plan of which it is a part provides for an irrevocable election by the employee, prior to the time his interest becomes distributable to him, to have distribution of such interest deferred to a fixed or determinable future time (such as 10 years or upon his prior retirement, severance of employment, death, or disability), his interest is not made available prior to such time or occurrence of any of the events enumerated. So long as the employee's election to defer the actual receipt of a distribution is irrevocable, it is immaterial whether the exercise of the election is in the form of positive action or merely inaction on the part of the employee.

In the instant case, Plan X participants have a right to receive a single sum distribution of their account balances if they make a prior irrevocable election pursuant to the amendment to Plan X and the election form. Participants who do not elect to receive a distribution of their account balances make a prior irrevocable election to either 1) transfer all or a portion of their account balances to Plan Z, and thereby defer distribution until death, disability, retirement, termination of employment, or withdrawal, or 2) have their insurance contracts transferred to them.

Therefore, with regard to ruling request 1, we conclude that participants entitled to termination distributions will not be deemed to have made available to them their interests in Plan X merely because each participant is allowed to make a prior irrevocable election, among several distribution options, to receive a single payment in cash or to defer payment to a future fixed or determinable time.

Section 4041 of ERISA provides rules with respect to which benefits are guaranteed by the PBGC upon the termination of a qualified plan.

Code section 401(a)(7) states that a trust shall not constitute a qualified trust unless the plan of which such trust is a part satisfies the requirements of Code section 411 (relating to minimum vesting standards).

Code section 411(d)(3) states that in order for a trust to satisfy the requirements of Code section 401, the plan of which such trust forms a part must expressly provide that, upon the termination or partial termination of the plan or, in the case of a plan to which Code section 412 does not apply, upon the complete discontinuance of contributions under the plan, the rights of each affected employee to benefits accrued to the date of such termination, partial termination, or discontinuance, to the extent funded as of such date, or the amounts credited to the employee's account, must be nonforfeitable.

Income Tax Regulations section 1.411(d)-2(c) states that a plan which falls under the jurisdiction of the PBGC is considered terminated on a particular date if, as of that date, the plan is voluntarily terminated by the plan administrator under section 4041 of ERISA, or the PBGC terminates the plan under section 4042 of ERISA.

Thus, if there is a plan termination for PBGC purposes, there is also a plan termination for purposes of section 402 of the Code.

Section 402(a)(5) of the Code provides that if the balance to the credit of an employee in a qualified trust is paid to him in a qualifying rollover distribution, and the employee transfers any portion of the property he receives in such distribution, within 60 days of receipt by the employee, to an eligible retirement program, then such distribution (to the extent so transferred) shall not be includible in gross income for the taxable year in which paid. The term "qualifying rollover distribution" means one or more distributions within one taxable year of the employee, for example, on account of a termination of the plan of which the trust is a part.

The aggregation rule of Code section 402(e)(4)(C) and the five year minimum participation rule of Code section 402(e)(4)(H) do not apply for purposes of determining whether distributions made on account of plan termination are eligible to be rolled over.

Therefore, we conclude, with regard to ruling request 2, that termination distributions made as single cash payments will be qualifying rollover distributions, within the meaning of Code section 402(a)(5)(D)(i)(I).

Section 1.401-1(b)(1) of the Regulations describes the types of retirement plans. Section 1.401-1(b)(1)(ii) states, in part, that a profit-sharing plan is a plan established and maintained by an employer to provide for the participation in his profits by his employees. Section 1.401-1(b)(1)(iii) defines a stock bonus plan as a plan established and maintained by an employer to provide benefits similar to that of a profit-sharing plan, except that the contributions by the employer are not necessarily dependent upon profits and the benefits are distributable in stock of the employer company. Rev. Rul. 71-256, 1971-1 C.B. 118, further explains that in order for a plan to be a stock bonus plan, the entire distribution (except for the value of a fractional part of a share) must be in stock of the employer corporation.

Section 1.401-1(b)(1)(i) of the Regulations defines a pension plan as a plan established and maintained by an employer primarily to provide systematically for the payment of definitely determinable benefits to his employees over a period of years, usually for life, after retirement. A plan designed to provide benefits for employees or their beneficiaries to be paid upon retirement or over a period of years after retirement will, for the purposes of section 401(a) of the Code, be considered a pension plan if the employer contributions under the plan can be determined actuarially on the basis of definitely determinable benefits, or as in the case of money purchase pension plans, such contributions are fixed without being geared to profits.

The following revenue rulings describe the forms a pension plan can take. In Rev. Rul. 66-205, 1966-2 C.B. 119, an employer established a plan under which the only contributions permitted to be made to the trust were employee contributions deducted from each employee's wages by the employer at the rate of X cents an hour. It was held that the fact that contributions to an employees' trust are limited to those of employees will not, of itself, preclude the qualification of the trust under section 401(a) of the Code, so long as the trust forms part of a pension plan.

In Rev. Rul. 74-385, 1974-2 C.B. 130, a money purchase pension plan provided for employee contributions which could vary year by year depending on the rate at which participants elect to contribute. Employer contributions were geared to the employee contributions. It was held that so long as the contributions are not subject to the discretion of the employer, this pension plan meets the requirement of definitely determinable benefits of section 1.401-1(b)(1)(i) of the Regulations.

Section 4.1 of Plan Z provides that participants shall make plan contributions by payroll deduction. Each member designates the amount of his contribution, from 2 to 10 percent of his annual compensation. Section 4.4 states that participating employers are not allowed to make contributions to Plan Z. Therefore, Plan Z cannot be characterized as a profit-sharing plan or a stock bonus plan because no employer contributions can be made to the plan. A lack of employer contributions is not a bar to the characterization of Plan Z as a pension plan, pursuant to Rev. Rul. 66-205. Rev. Rul. 74-385 indicates that plan benefits are definitely determinable even though employee contributions may vary. Thus, Plan Z is a pension plan, as are Plans X and Y.

A lump sum distribution, within the meaning of section 402(e)(4)(A) of the Code, is given special tax treatment under several methods, whether received by the employee or his beneficiary.

The term "lump sum distribution" means the distribution or payment, within one taxable year of the recipient, of the balance to the credit of an employee which becomes payable to the recipient, for example, on account of the employee's separation from service or after the employee has attained age 59 1/2.

Section 402(e)(4)(C) of the Code states, in pertinent part, that for purposes of determining the balance to the credit of an employee under section 402(e)(4)(A), all pension plans maintained by the same employer shall be treated as a single plan, all profit-sharing plans maintained by the employer shall be treated as a single plan, and all stock bonus plans maintained by the employer shall be treated as a single plan.

In the case at hand, Plans X, Y and Z are pension plans. Therefore, with regard to ruling requests 3 and 4, we conclude that under the aggregation rules of Code section 402(e)(4)(C), Plans X, Y and Z will be considered a single plan for purposes of determining whether distributions are lump sum distributions within the meaning of Code section 402(e)(4)(A).

Section 3.01 of Revenue Procedure 80-24, 1980-26 I.R.B. 30, states that the National Office may issue rulings involving employee plans matters under section 401 through 415 of the Code, except as provided in section 3 of Rev. Proc. 80-30, 1980-26 I.R.B. 56. Section 3.01 of Rev. Proc. 80-30 provides that District Directors of key district offices shall issue determination letters involving the provisions of section 401 of the Code when there is a termination of a plan and trust. Therefore, we are unable to issue a ruling with regard to ruling request 5. However, we are providing you with the following general information.

Section 1.401-1(b)(1)(i) of the Regulations states that a qualified pension plan is a plan established and maintained by an employer primarily to provide systematically for the payment of definitely determinable benefits to his employees over a period of years, usually for life, after retirement. Benefits are not definitely determinable if funds arising from forfeitures on termination of service, or any other reason, may be used to provide increased benefits for the remaining participants. The rules regarding forfeitures under a qualified pension plan are further explained in section 1.401-7 of the Regulations. This section provides that forfeitures arising from a severance of employment, death, or for any other reason, must not be applied to increase the benefits any employee would otherwise receive under the plan prior to the termination of the plan or the complete discontinuance of employer contributions.

Section 1.401-6(a)(2)(i) of the Regulations provides that a qualified plan must provide for the allocation of any previously unallocated funds to the employees covered by the plan upon the termination of the plan or the complete discontinuance of contributions under the plan.

Plan X has provided that dividends payable on insurance contracts are to be paid to the trustee to be held in a general fund and applied to reduce the subsequent year's premium payments by the employer. Since Plan X has been terminated, no premiums will be payable in the future. Therefore, it is proposed that Plan X be amended to provide that dividends payable after the date of termination be allocated directly to each contract on which dividends are payable, thus increasing the cash surrender value and termination distributions payable to the participants.

We note that dividends that are allocated to Plan X participants after the termination of Plan X are not derived from any participant's accrued benefits but, rather, stem from unallocated funds.

With regard to ruling request 6, section 1.402(a)-1(a)(2) of the Regulations provides that when a qualified trust distributes a retirement income, endowment, or other life insurance contract, the entire cash value of the contract at the time of distribution must be included in the distributee's income in accordance with Code section 402, except to the extent that, within 60 days after the distribution of such contract, all or any portion of such value is irrevocably converted into a contract under which no part of any proceeds payable on death at any time would be excludable under Code section 101(a) (relating to life insurance proceeds).

In Rev. Rul. 66-322, 1966-2 C.B. 123, retirement income contracts were received by a distributee from a qualified employees' pension trust. At the time the contracts were distributed by the trustee to the distributee, the cash surrender value or reserve payable as death benefits exceeded the stated face amount of the contracts. This Revenue Ruling went on to say that the mere fact that such a contract may contain provisions permitting the application or the conversion of its reserve (the cash value or the maturity value), to provide annuity benefits does not make such a contract an annuity contract, unless, and until, such conversion takes place. Rev. Rul. 66-322 held that the mere elimination of the risk factor, i.e., that the reserve exceeded the face amount of the contract, is not considered to be a conversion of the insurance contract into an annuity contract for purposes of section 1.402(a)-1(a)(2) of the Regulations.

In the case at hand, the retirement income and endowment policies used to fund Plan X provide that pursuant to an election upon maturity and termination of the policy for its net cash value on any policy anniversary date, policy proceeds may be placed under any one of the several settlement options. These options provide for various types of installment payments. These insurance policies further state that, if the payee dies before receiving full payments under the settlement options which he has elected, a single sum payment shall be made to his executor. This payment shall be equal to the commuted value of any unpaid installments. Therefore, an election of current payment under the settlement options terminates the pre-retirement death benefit under the insurance contract. Rev. Rul. 66-322 is distinguishable because no attempt was made to apply the cash value of the retirement income contract to provide annuity benefits. Therefore, with regard to ruling request 6, we conclude that a participant electing to take his termination distributions in the form of assignment of the retirement income and endowment contracts purchased to fund his benefits under Plan X will be deemed to have converted such contracts into nontransferable annuity contracts under which no part of any proceeds payable on death would be excludable from income under Code section 101(a) if within 60 days of receiving the contracts he elects to begin receiving benefits under the contracts immediately under any of the settlement options available under the contract.

Section 72(f) of the Code provides that amounts contributed to an insurance contract by the employer but includible in the employee's gross income are to be considered the employee's contributions. In explaining Code section 72(f), Regulations section 1.72-8(a)(1) states that section 72(f) provides that, for purposes of sections 72(c), 72(d), and 72(e), amounts contributed by an employer for the benefit of an employee or his beneficiaries shall constitute consideration paid or contributed by the employee to the extent that such amounts are includible in the gross income of the employee. This applies to premiums paid by an employer or with trust assets for life insurance protection for an employee to the extent such premiums are includible in the gross income of the employee when paid.

Section 1.72-16 of the Regulations was promulgated under Code section 72(m)(3), relating to insurance contracts. Section 1.72-16(b)(1) states, in general, that the rules found in section 1.72-16 apply to any life insurance contract purchased by a trust described in Code section 401(a), which is exempt from tax under Code section 501(a), if the proceeds of the contract are payable directly or indirectly to a participant in such trust. A payment of the proceeds of a life insurance contract to a participant will be considered an indirect payment where they are payable to the trustee but, under the terms of the plan, the trustee is required to pay over all of such proceeds to the participant.

Regulations section 1.72-16(b)(2) states that if under a qualified plan or trust, amounts which were allowed as a deduction under section 404 are applied toward the purchase of a life insurance contract, the cost of the life insurance protection under such contract shall be included in the gross income of the participant for the taxable year or years in which such contributions are so applied.

However, section 1.72-16(b)(4) of the Regulations provides that the amount includible in the gross income of the employee shall be considered as premiums or other consideration paid or contributed by the employee, but only with respect to any benefits attributable to the contract (within the meaning of section 1.72-2(a)(3) of the Regulations) providing the life insurance protection.

Although separately provided and funded retirement benefits and life insurance may be two separate programs of interrelated contributions and benefits under Regulations section 1.72-2(a)(3)(ii), retirement benefits and life insurance are considered part of a single separate program of interrelated contributions and benefits to the extent both are provided under one retirement income, endowment, or other contract providing life insurance protection.

In Rev. Rul. 67-336, 1967-2 C.B. 66, plan participants' lives were insured by life insurance policies purchased by the trustee. On or before a participant's retirement date, the trustee surrendered the life insurance policy on the participant's life for its cash value. Thereafter, the cash received upon the surrender of the insurance contract was used by the trustee to purchase for the participant an annuity contract. The Revenue Ruling held that the employee's consideration for the annuity contract does not include the portion of the premiums payable under the insurance policy and which were included in the employee's gross income.

In the case at hand, participants who elect to take assignment of the retirement income and endowment contracts and thereafter elect immediate payment under one of the contract settlement options will receive a distribution of the contract on which the P.S.-58 costs were paid. The form the distribution takes (the various settlement options) is immaterial as long as the distribution is attributable to the life insurance contract. Therefore, we conclude, with regard to ruling request 7, that P.S.-58 costs that were taxable as income to the participant will be considered employee contributions for purposes of applying the Code section 72 employee contribution recovery rules to payments made under the contracts to participants who (1) elect to take termination distribution in the form of assignment of the endowment and retirement income contracts purchased to fund their plan benefits and (2) elect to have the payment of benefits commence immediately under any of the settlement options available under such contract.

Section 402(a)(5) of the Code provides that if the balance to the credit of an employee in a qualified trust is paid to him in a qualifying rollover distribution, such as on account of plan termination, and within 60 days after the date of distribution the employee transfers any portion of the property he receives in such distribution to an eligible retirement plan, such as an IRA or another qualified trust, then such distribution (to the extent so transferred) shall not be includible in gross income for the taxable year in which paid.

Section 402(a)(1) of the Code provides that the amount actually distributed or made available to any distributee by an employees' trust described in section 401(a) which is exempt from tax under section 501(a) shall be taxable to him, in the year in which so distributed or made available, under section 72 (relating to annuities).

Section 1.72-1(a) of the Regulations provides, in general, that amounts subject to the provisions of section 72 are includible in the gross income of the recipient except to the extent that they are considered to represent a reduction or return of premiums or other consideration paid.

Further, section 1.72-1(b) provides that for the purpose of determining the extent to which amounts received represent a reduction or return of premiums or other consideration paid, the provisions of section 72 distinguish between "amounts received as an annuity" and "amounts not received as an annuity." In general, "amounts received as an annuity" are amounts which are payable at regular intervals over a period of more than one full year from the date on which they are deemed to begin, provided the total of the amounts so payable or the period for which they are to be paid can be determined as of that date. Any other amounts to which the provisions of section 72 apply are considered to be "amounts not received as an annuity."

Section 1.72-11(b) of the Regulations, promulgated under section 72(e)(1)(B) of the Code, provides that if payments in the nature of a return of premiums or other consideration are received before the annuity starting date or before the date on which an amount is first received as an annuity, whichever is later, such payments are includible in the gross income of the recipient, but only to the extent that they, when taken together with all previous payments received under the contract which were excludable from the gross income of the recipient under the applicable income tax law, exceed the aggregate of premiums or other consideration paid or deemed to have been paid by the recipient. Such payments shall be subtracted from the consideration paid (or deemed paid) for the purpose of determining the tax consequences of subsequent distributions under the plan.

Therefore, we conclude, with regard to ruling request 8, that if a participant makes an IRA rollover contribution or elects to transfer to Plan Z an amount less than his total interest in Plan X, the amount not rolled over or transferred and distributed to him in cash will be includible in taxable income only to the extent it exceeds the amount of the employee contributions made by the participant to Plan X.

We wish to point out, as indicated above, that the amount of the P.S.-58 costs previously taxed to a participant are considered employee contributions within the meaning of Code section 402(a)(5)(B) and, thus, cannot be rolled over.

With regard to ruling request 9, we conclude that for purposes of computing the amount of a termination distribution that is excludable from income as a return of employee contributions under Code section 72, retirement income or endowment contracts assigned to the participant may be deemed to be a return of employee contributions in the amount of their cash surrender value that is not in excess of the contributions made by the participant to Plan X.

We also conclude, with respect to ruling request 10, that for purposes of computing the portion of a termination distribution that is excludable as a return of employee contributions, the P.S.-58 costs the participant reported as income on any contract actually assigned to the participant will be considered recoverable employee contributions whether or not the participant elects an immediate payout under one of the settlement options.

Rev. Rul. 68-160, 1968-1 C.B. 67, provides that the transfer of funds from one qualified trust to another qualified trust through the trustees of the plans does not result in funds being distributed or made available.

In the present case, the Termination Distribution Election Form provides that an employee may transfer 1) his or her entire account to Plan Z, 2) his or her taxable amount to Plan Z, or 3) his or her taxable amount plus any portion of the employee contributions. The transfer will be accomplished through the trustees of Plans X and Z.

Based on the foregoing, we conclude, with regard to ruling request 11, that election by a participant to have all or part of his interest in Plan X transferred by the trustee to Plan Z will not cause the amounts transferred to be considered made available or distributed to the participant.

Rev. Rul. 59-185, 1959-1 C.B. 86, provides that a qualified plan may permit voluntary employee contributions of up to 10 percent of compensation where such employee contributions do not affect the allocation of employer contributions.

Assuming the contributions by employees to Plan X previously met the restrictions of Rev. Rul. 59-185 when they were contributed, the amounts of such employee contributions transferred from Plan X to Plan Z will not be taken into account for purposes of computing the 10 percent limitation on voluntary employee contributions for the year in which the transfer occurs.

Section 415(c) of the Code permits annual contributions and other annual additions to defined contribution plans provided that certain limitations are not exceeded. Subsection (2) defines an annual addition as the sum of employer contributions, forfeitures, and the lesser of an employee's contributions in excess of six percent of his compensation or one-half of the employee contribution.

The flush language of section 415(c) and of section 4.02 of Revenue Ruling 75-481, 1975-2 C.B. 188, which contains guidelines on section 415(c) limitations, indicates that "employee contributions" are determined without regard to any rollover contributions. The rationale for permitting exclusion of rollover contributions is that since the rollover amount was previously subjected to the section 415(c) limitation under a prior plan, a mere rollover of that amount from one plan to another plan does not affect the computation of the limitations. The same rationale applies to a trustee to trustee transfer of amounts under a qualified plan.

Where employer and employee contributions are taken into account under section 415 of the Code for limitation years under one plan and are merely transferred to another plan, the amounts transferred will not be taken into account as part of the current year's annual addition to the transferee plan for purposes of section 415(c).

Based on the foregoing, we conclude, with regard to ruling request 12, that (a) employee and employer contributions may be transferred to Plan Z without affecting the 10 percent limit on voluntary employee contributions for the year of transfer, and (b) transferred amounts will not be considered annual additions, within the meaning of Code section 415(c)(2), for the year of such transfer.

In accordance with a letter from your authorized representative, ruling request 13 has been withdrawn.

The above rulings are based on the assumption that Plans X, Y and Z will be qualified under section 401(a) of the Code and their related trusts will be tax-exempt under section 501(a) at the time the above transactions take place.

A copy of this letter has been sent to your authorized representative pursuant to the instructions contained in a power of attorney on file in this office.

Sincerely yours,

John J. Swieca

Acting Chief, Employee Plans

Technical Branch

Written Determination

Number: 8445095

Internal Revenue Service

August 13, 1984

Symbol: OP:E:EP:RQ:2:6

In your correspondence of ***** 1983, as modified by your letter dated ***** 1984, rulings were requested concerning the federal income tax consequences of the purchase of life insurance on the lives of participants and their dependents according to the terms of Plan X.

The information submitted states that Plan X contains a qualified cash or deferred arrangement as described in section 401(k) of the Internal Revenue Code (Code). According to the terms of Plan X, a participant may elect to have part of his/her employer contribution account balance invested in one or more permanent life insurance policies on the life of the participant and/or his/her spouse. In addition, a rider for pure term insurance on the lives of the participant's children may be attached to any primary policy.

If a participant terminates employment, all life insurance policies will be assigned to the participant and/or surrendered for cash and the cash proceeds distributed to the participant in accordance with one of the forms of distribution permitted under Plan X. If a participant dies after the proceeds have been paid to the trustee, the proceeds of his/her policy shall be paid in accordance with the terms of the written beneficiary designation filed by the participant or to the estate of the deceased participant.

In the event of the death of a participant's spouse or child, the proceeds of his/her policy will be paid to the trustee. The trustee will then pay to the participant the proceeds less any cash value under such contract. Such cash value shall be invested in the participant's account balance until such time as a distribution of account funds are permitted. In the alternative, the participant may elect to have the total proceeds allocated to his/her account for distribution at a later date.

Ruling Request 1:

The cost of such insurance will be included in the income of the participant based on the face value of the policies, less cash value, times the appropriate mortality cost.

Analysis:

Section 72(m)(3) of the Code and section 1.72-16(b) of the Federal Income Tax Regulations govern the treatment of the cost of life insurance purchased by a trust described in section 401(a) which is exempt from tax under section 501(a) if the proceeds of such contract are payable directly to a participant, his beneficiary, or to the trustee for the benefit of the participant or his beneficiary. If amounts which were allowed as a deduction under section 404 of the Code or earnings of the trust are applied toward the purchase of a life insurance contract, the cost of the life insurance protection under such contract shall be included in the gross income of the participant for the taxable year(s) in which such contributions or earnings are so applied. However, if the amount payable upon death at any time during the pear exceeds the cash value of the insurance policy it the end of the year, the entire amount of such excess is considered current Life insurance protection. The cost of such insurance will be considered to be a reasonable net premium cost, as determined by the Commissioner, for such amount of insurance for the appropriate period.

Section 1.72-16(b)(1)(ii) of the regulations provides that the proceeds of a life insurance contract purchased by a qualified and tax-exempt employees' trust will be considered payable indirectly to a participant or his beneficiary where they are payable to the trustee if, under the terms of the plan, the trustee is required to pay over all of such proceeds to the beneficiary. In the instant case, the proceeds of any insurance policy on the life of a participant, a spouse, or child are payable directly or indirectly to the participant.

Accordingly, we conclude that the cost of such insurance is includible in the gross income of the participant in the year(s) in which employer contributions to Plan X, or the earnings thereon, are applied to such purchase. The cost of the insurance may reasonably be determined by multiplying the excess of the contract's face value over its cash surrender value by the appropriate mortality cost.

With regard to ruling requests two and five, section 402(a) of the Code provides that amounts distributed from an employees' trust shall be taxable to the distributee under section 72, relating to annuities. Section 72(e)(2)(B)(ii) of the Code provides that amounts not received as annuities received before the annuity starting date shall not be included in gross income to the extent allocable to investment in the contract. Section 72(f) of the Code defines "investment in the contract" to include amounts contributed by an employer to the extent that such amounts were includible in the gross income of the employee. Section 1.402(a)-1(a)(1)(iii) of the regulations provides that a distribution of property by a qualified plan shall be taken into account by the distributee at its fair market value. Accordingly, we conclude with respect to ruling request two, that the distribution from Plan X of a life insurance contract, or the proceeds from a surrendered contract upon termination of employment, shall be included in gross income at cash value or the amount of the cash proceeds to the extent the cash value was not previously includible in gross income of the employee. With regard to ruling request five, any proceeds from insurance on a spouse or child of the participant which remained in the plan will be taxed when distributed as distributions from a qualified plan.

With regard to ruling requests three and four, section 72(m)(3)(C) of the Code provides that in the case of the death of an individual insured under a contract purchased by a trust described in section 401(a) which is exempt from tax under section 501(a), if the proceeds of such contract are payable directly or indirectly to a participant in such trust or to a beneficiary of such participant, in amount equal to the cash surrender value of the contract immediately before the death of the insured shall be treated as a payment under such plan or a distribution by such trust, and the excess of the amount payable by reason of the death of the insured over such cash surrender value shall not be included in gross income under this section and shall be treated as provided in section 101, relating to the treatment of death benefits. Accordingly, we conclude that the distribution of any excess insurance proceeds over the cash surrender value of the contract determined as of the date immediately prior to the death of an individual insured under the provisions of Plan X will be treated as a distribution of insurance proceeds under section 101(a) rather than as a distribution from a qualified plan.

Written Determination

Number: 8539066

Internal Revenue Service

July 1, 1985

Symbol: OP:E:EP:RQ:2:7

Uniform Issue List No.: 0402.01-01

Attn: * * *

Legend:

Company M = * * *

Trustee N = * * *

Plan A = * * *

Plan B = * * *

Trust Y = * * *

Gentlemen:

This is in response to a ruling request dated July 25, 1984, as modified and supplemented by letters up to and including March 4, 1985, submitted on your behalf by your authorized representative concerning the federal income tax consequences of distributions from Plan A and Plan B under section 402 of the Internal Revenue Code.

The information submitted indicates Company M maintains Plan A and Plan B for the benefit of its employees. Plan A, a profit sharing plan, was established on September 28, 1943. Plan B, a profit sharing plan under section 401(k) of the Code was established effective July 1, 1983. Plans A and B are both funded under Trust Y which was restated and amended effective July 1, 1983.

Company M previously maintained a defined benefit pension plan. In October 1972, Company M transferred and merged this qualified benefit trust into Plan A. As a part of the merger the whole life insurance policies which were credited to each participant in the benefit plan trust were also transferred to Plan A. Premium payments for these life insurance policies held in Plan A pursuant to each participant's direction were either deducted from the participant's account balance in Plan A or paid for with voluntary contributions made by the participant to Trustee N. Distributions from Plan A may be in a lump sum or in installments over a period not to exceed ten years. Participants of Plan A who participated in the benefit trust plan are given the following options with respect to the insurance policies held by Plan A:

1. Conversion of the policies for their cash surrender value, which amount is then added to the Plan A account balance on distribution.

2. Convert the policies to paid-up status which reduces the face amount and discontinues renewal premiums.

3. Transfer ownership of the policies to the participant who may then continue making premium payments.

4. Utilize the cash surrender value of the policies to purchase a fully paid, nontransferable annuity.

5. Transfer ownership of the policies to the participant where the amounts in excess of cumulative P.S. 58 costs are stripped from the policy and added to the Plan A account balance on distribution.

In accordance with the foregoing, you have requested the following rulings:

1(a). Any employee who terminates his employment with Company M and who receives the balance to his credit in Plan A and Plan B within one of his taxable years, shall be entitled to treat that portion of the distribution allocable to pre-1974 active participation in Plan A as subject to capital gain rates under section 402(a)(2) of the Code.

1(b). Further, if such individual was a participant in Plan A or Plan B, or both, for five or more taxable years before the taxable year of distribution, then he may treat that portion of the distribution (from the plan(s) in which he had five or more years of participation) allocable to post-1973 plan participation as subject to taxation under section 402(e)(1) of the Code or to treat the entire such distribution as taxable under section 402(e)(1), in which case the entire amount of the lump sum distribution (from the plan(s) in which he had five or more years of participation) shall be subject to the tax imposed by section 402(e)(1) of the Code. That portion of the lump sum distribution from the plan(s) in which he did not have five years of participation shall be taxed as ordinary income.

2. Any employee who terminates his employment with Company M and who receives the balance to his credit in Plan A and Plan B within one taxable year shall be entitled to roll over all or a portion of such distribution into an individual retirement account (IRA) under the provision of section 402(a)(5) of the Code and if such rollover is made within sixty (60) days of receipt, such individual shall not be subject to tax on the amount rolled over.

For ruling requests three through eight, the following facts are related to the receipt of whole life insurance policies or their cash surrender value from Plan A due to the merger of a prior benefit plan trust (which was merged) into Plan A in 1972. These facts apply to any employee who:

a) terminates his employment with Company M;

b) receives the balance to his credit in Plan A and Plan B;

c) was a participant in the prior defined benefit plan trust which merged into Plan A in 1972;

d) was a participant in plan A for five or more taxable years before the year of distribution; and

e) premium payments for the whole life insurance maintained in Plan A were made from Plan A account balance or by the employee as a voluntary contribution to the Plan, or both.

3. If the participant directs Trustee of Plan A to convert the whole life insurance policies to their cash surrender value, which amount is then added to his Plan A account balance, upon distribution his basis (and therefore amounts which are non-taxable) in the amount distributed from Plan A will include his voluntary contributions, and not his aggregate P.S. 58 costs, if the individual elects to treat his distribution as taxable under section 402(e)(1) of the Code.

4. If the participant directs Trustee of Plan A to convert the whole life insurance policies to their cash surrender value, which amount is then added to his Plan A account balance, his entire distribution, net the voluntary employee contributions, may be rolled over into an IRA if such rollover is made within sixty (60) days of receipt.

5. If the participant directs Trustee of Plan A to reduce his life insurance policies cash surrender value to the amount of his aggregate P.S. 58 costs and such cash surrender value is then added to his Plan A account balance and distributed in addition to the life insurance policies, such individual's basis in the lump sum distribution will include his voluntary contributions if the individual elects to treat his distribution as taxable under section 402(e)(1) of the Code.

6. If the participant directs Trustee of Plan A to reduce his life insurance policies cash surrender value to the amount of his aggregate P.S. 58 costs and such cash surrender value is then added to his Plan A account balance and distributed in addition to the life insurance policies, and such individual rolls over his lump sum distribution into an IRA within sixty (60) days of receipt from Plan A, the insurance policy and voluntary contributions may not be included in the rollover contribution.

7. If the participant elects to receive a reduced, paid up, deferred annuity, such annuity may be rolled over into an IRA within sixty (60) days of receipt.

8. If the participant elects to direct Trustee of Plan A to convert his policies to their cash surrender value and use the cash surrender value (but no part of his Plan A account balance) to purchase an annuity contract with the same or different carrier, the individual's aggregate P.S. 58 costs are not preserved with respect to such annuity contract.

Section 402(a)(1) of the Code provides that the 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 him in the year in which so distributed, under section 72 (relating to annuities).

Section 402(e)(4)(A)(iii) of the Code defines a lump sum distribution as a distribution or payment from a qualified employees' trust, within one taxable year of the recipient, of the balance to the credit of the employee which becomes payable to the recipient on account of the employee's separation from the service of the employer.

Section 402(e)(4)(H) of the Code provides that no amount distributed to an employee from or under a plan may be treated as lump sum distribution within the meaning of section 402(e)(4)(A) for purpose of section 402(e)(1) (relating to ten-year averaging treatment), but not for purposes of section 402(a)(2) or section 402(a)(5) (relating to capital gains or rollover treatment) unless he has been a participant in the plan for five or more taxable year in which such amount is distributed.

Section 402(e)(4)(C) of the Code provides that for purposes of determining the balance to the credit of an employee all trusts which are part of a plan shall be treated as a single trust, all pension plans maintained by the employer shall be treated as a single plan, all profit-sharing plans maintained by the employer shall be treated as a single plan, and all stock bonus plans maintained by the employer shall be treated as a single plan.

Section 402(a)(2) of the Code provides that so much of the total taxable amount of a lump sum distribution as is equal to the product of such total taxable amount multiplied by a fraction:

(a) the numerator of which is the number of calendar years of active participation by the employee in such plan before January 1, 1974, and

(b) the denominator of which is the number of calendar years of active participation by the employee in such plan,

shall be treated as a gain from the sale or exchange of a capital asset held for more than six months.

Section 402(e)(1) of the Code provides for the imposition of a separate tax, referred to as ten-year averaging, on the ordinary income portion "of a lump sum distribution." Section 402(e)(4)(E) defines the "ordinary income portion" as the total taxable amount of the lump sum distribution multiplied by a fraction:

(i) the numerator of which is the number of calendar years of active participation by the employee in such plan after December 31, 1973, and

(ii) the denominator of which is the number of calendar years of active participation by the employee in such plan.

Section 402(e)(4)(D) defines "total taxable amount" as the amount of a lump sum distribution which exceeds the sum of:

(i) the amounts considered contributed by the employee (determined by applying section 72(f)), which employee contributions shall be reduced by any amounts theretofore distributed to him which were not includible in gross income, and

(ii) the net unrealized appreciation attributable to that part of the distribution which consists of the securities of the employer corporation so distributed.

The ordinary income portion of a lump sum distribution under two or more plans that are treated as a single plan under the aggregation rules of section 402(e)(4)(C) of the Code is equal to the sum of the amounts that would constitute the ordinary income portions of lump sum distributions under each plan, determined as if the plans are not subject to the aggregation rules. The ordinary income portion of a lump sum distribution does not include any amount distributed under a plan with respect to which the 5-year minimum participation requirement described in section 402(e)(4)(H) of the Code is not satisfied.

Accordingly, with respect to section (a) of your first ruling request concerning those employees who separate from the service of Company M and receive total distributions from two or more plans, we conclude that any employee who terminates his employment with Company M and who receives the balance to his credit in Plan A and Plan B within one of his taxable years, shall be entitled to treat that portion of the distribution allocable to pre-1974 active participation in Plan A as subject to capital gain rates under section 402(a)(2) of the Code. Further, with respect to section (b) of your first ruling request, we conclude that if such individual was a participant in Plan A or Plan B, or both, for five or more taxable years before the year of distribution, then he may treat that portion of the distribution (from the plan(s) in which he had five or more years of participation allocable to post-1973 plan participation as subject to taxation under section 402(e)(1) of the Code or to treat the entire such distribution as taxable under section 402(e)(1), in which case the entire amount of the lump sum distribution (from the plan(s) in which he had five or more years of participation) shall be subject to the tax imposed by section 402(e)(1) of the Code. That portion of the lump sum distribution from the plan(s) in which he did not have five years of participation shall be taxed as ordinary income.

Section 402(a)(5) of the Code, as amended by the Deficit Reduction Act of 1984, P.L. 98-389 (Act), provides that if (i) any portion of the balance to the credit of an employee in a qualified trust is paid to him, (ii) the employee transfers any portion of the property he receives in such distribution to an individual retirement account (as described in section 402(a)(5)(E)(iv)(I) of the Code as amended by the Act), and (iii) in the case of a distribution of property other than money, the amount so transferred consists of the property distributed, then such distribution (to the extent so transferred) shall not be includible in gross income for the taxable year in which paid.

Section 402(a)(5)(B) of the Code as amended by the Act, states, in pertinent part, that in the case of any qualified total distribution, the maximum amount transferred shall not exceed the fair market value of all the property the employee receives in the distribution, reduced by the employee contributions (other than accumulated deductible employee contributions within the meaning of section 72(o)(5)).

A qualified total distribution is defined in section 402(a)(5)(E)(i) of the Code, in pertinent part, as one or more distributions which constitute a lump sum distribution within the meaning of section 402(e)(4)(A) (determined without reference to subparagraphs (B) and (H) of subsection (e)(4)).

Section 402(a)(5)(C) of the Code states that section 402(a)(5)(A) shall not apply to any transfer of a distribution made after the 60th day following the day on which the employee received the property distributed.

Accordingly, with respect to your second ruling request we conclude that any employee who terminates his employment with Company M and who receives the balance to his credit in Plan A and Plan B within one taxable year shall be entitled to rollover all or a portion of such distribution into an IRA under the provisions of section 402(a)(5) of the Code and if such rollover is made within 60 days of receipt, such individual shall not be subject to tax on the amounts rolled over.

Section 72(m)(3) of the Code provides that any contribution to a trust described in section 401(a) which is exempt from tax under section 501(a) of the Code, and any income of such trust, which have been used to purchase the life insurance protection under a contract where the proceeds of such contract are payable directly or indirectly to a participant in such trust or to a beneficiary of such participant, is includible in the gross income of the participant for the taxable year when so applied.

Section 1.72-8(a)(1) of the Income Tax Regulations provides that for purposes of determining an employee's investment in an annuity contract, amounts contributed by an employer for the benefit of an employee or his beneficiaries shall constitute consideration paid or contributed by the employee for the contract to the extent that such amounts were includible in the gross income of the employee under subtitle A of the Code or prior tax laws.

Section 1.72-16(b)(4) of the regulations, dealing with the treatment of the cost of life insurance protection, however, provides that the amount includible in the gross income of the employee under this paragraph shall be considered as premiums or other consideration paid or contributed by the employee only with respect to any benefits attributable to the contract (within the meaning of section 1.72-2(a)(3) of the regulations dealing with separated programs consisting of interrelated contributions or benefits being treated as a single contract) providing the life insurance protection.

Revenue Ruling 67-337 [sic; Rev. Rul. 67-336], 1967-2 C.B. 66, held that the employee's consideration for the annuity contract within the meaning of section 72 of the Code, which contract was purchased by the trustee of the exempt employees' trust with the proceeds of the surrendered life insurance policy, does not encompass the portion of the premiums included in the employee's gross income because it was paid for life insurance protection under a surrendered policy. In that ruling, the trustee surrendered the policy on which the employee had previously been taxed. Whether the surrender value is issued to provide a new contract (as in Rev. Rul. 67-336) or to provide a lump-sum cash distribution, the employee has no basis in these P.S. 58 costs since the actual contract on which he was originally taxed is not included in the distribution.

Accordingly, with respect to your third ruling request, we conclude that if the participant directs Trustee of Plan A to convert the whole life insurance policies to their cash surrender value, which is then added to his Plan A account balance, upon distribution, his basis (and therefore amounts which are non-taxable) in the amount distributed from Plan A will include his voluntary contributions, and not his aggregate P.S. 58 costs, if the individual elects to treat his distribution as taxable under section 402(e)(1) of the Code.

We conclude, with regards to your fourth ruling request, that if the participant directs Trustee of Plan A to convert the whole life insurance policies to their cash surrender value, which amount is then added to his Plan A account balance, his entire distribution, net the voluntary employee contributions, may be rolled over into an IRA if such rollover is made within sixty (60) days of receipt.

With regards to your fifth ruling request, we conclude that if the participant directs Trustee of Plan A to reduce his life insurance policies cash surrender value to the amount of his aggregate P.S. 58 costs and such cash surrender value is then added to his Plan A account balance and distributed in addition to the life insurance policies, such individual's basis in the lump sum distribution will include his voluntary contributions if the individual elects to treat his distribution as taxable under section 402(e)(1) of the Code.

We conclude, with respect to your sixth ruling request, that if the participant directs Trustee N to reduce his life insurance policies cash surrender value to the amount of his aggregate P.S. 58 costs and such cash surrender value is then added to his Plan A account balance and distributed in addition to the life insurance policies, and such individual rolls over his lump sum distribution into an IRA within sixty (60) days of its receipt from Plan A, the insurance policy and voluntary contributions may not be included in the rollover contribution.

We conclude, with regards to your seventh ruling request, that if the participant elects to receive a reduced, paid up, deferred annuity, such annuity may be rolled over into an IRA within sixty (60) days of receipt.

With respect to your eighth ruling request, we conclude that if the participant elects to direct Trustee of Plan A to convert his policies to their cash surrender value and use the cash surrender value (but no part of this Plan A account balance) to purchase an annuity contract with the same or different carrier, the individual's aggregate P.S. 58 costs are not preserved with respect to such annuity contract.

These rulings are based upon the assumptions that Plan A and Plan B will be qualified under section 401(a) of the Code, and their related trust exempt from tax under section 501(a) at the time of the distributions.

A copy of this ruling has been sent to your authorized representative in accordance with the power of attorney on file with this office.

Sincerely yours,

John J. Swieca

Chief, Employee Plans Rulings

and Qualifications Branch

Written Determination

Number: 8721083

Internal Revenue Service

February 25, 1987

Symbol: OP:E:EP:R:7

Uniform Issue List No.: 0072.05-00

LEGEND:

Company M = * * *

Plan X = * * *

Gentlemen: * * *

This is in response to a ruling request dated April 17, 1985, as supplemented by a letter dated December 16, 1985, and a telephone conversation on February 3, 1987, submitted on your behalf by your authorized representative concerning the federal income tax consequences of distributions from Plan X.

The information submitted shows that Company M adopted Plan X, a defined benefit plan, on September 1, 1959. On May 5, 1977, the Internal Revenue Service issued a favorable determination letter as to Plan X's qualification under section 401(a) of the Internal Revenue Code. A subsequent letter dated April 23, 1979, was issued, and an application for a new favorable determination letter is currently pending. Plan X's trustee has maintained an investment fund to accumulate the funds necessary to provide the participants' retirement benefits.

Prior to September of 1978, Plan X's trustee invested the trust funds in whole life insurance policies on the lives of the various participants as well as in an auxiliary investment fund. For each year prior to September, 1978, Company M reported to each participant an additional amount representing the P.S. 58 costs (those costs of the participant's current life insurance under Plan X). This amount was includible in the participant's taxable income.

On September 12, 1978, Plan X was amended in its entirety and restated effective September 1, 1978. Two major changes caused by Plan X's amendment were that death benefits for participants before age 65 were eliminated and the trust was to be funded entirely by employer contributions invested in various securities rather than partially, as before, in whole life insurance policies.

On October 5, 1978, Plan X's trustees unilaterally decided to redeem the individual whole life policies and invested the trust proceeds thereof in securities. None of the participants had any control or voice in the conversion or change in Plan X's investment vehicle. However, prior to the funding conversion, the participants could have assumed their individual whole life insurance policies if they paid the cash surrender value of the policies. None of the participants did so.

On February 11, 1980, Company M obtained a letter of approval from the Internal Revenue Service regarding the change in Plan X's funding method. In part, the letter also approved the method by which the transition from the prior to the new funding method was to be made whereby Plan X's unfunded accrued liability due to the change, plus the credit balance at the time of change, was to be amortized over thirty years.

In accordance with the foregoing, you have requested the following rulings:

1. That the entire employee benefit arrangement between the employee/participant and Company M as the trustee and plan administrator embodied in Plan X consisting of the various programs and deductions, contributions, and payments pursuant to Plan X is a single contract for federal tax purposes.

2. That the portion of the employer contributions which was included in the gross income of the employee/participant as P.S. 58 costs constitutes consideration paid for the "contract" by the employee/participant for purposes of determining the employee/participant's investment in the contract.

3. That upon a distribution from Plan X with respect to a particular participant, the portion of such distribution representing a return of that participant's investment in the "contract" shall be received, tax free, by the distributee.

4. That in completing a Form 1099 for any year in which there was any distribution from Plan X with regard to a participant who was previously taxed on a portion of such distribution as P.S. 58 costs, the trustee of Plan X shall not include the portion attributable to such P.S. 58 costs in the amount of the distribution from Plan X taxable to the recipient but rather shall indicate that such portion is a tax-free return of investment in the contract.

Section 402(a)(1) of the Code provides, in part, that the amount actually distributed to any distributee by any employee's trust described in section 401(a) which is exempt from tax under section 501(a) shall be taxable to such distributee in the year distributed under section 72.

Section 1.72-2(a)(3)(i) of the Income Tax Regulations provides that for the purposes of applying section 72 of the Code to distributions and payments from qualified plans, each separate program of the employer consisting of interrelated contributions and benefits shall be considered a single contract. Section 1.72-2(a)(3)(ii) of the regulations lists the following types of benefits and the contributions used to provide them, as examples of separate programs of interrelated contributions and benefits:

(a) Definitely determinable retirement benefits.

(b) Definitely determinable benefits payable prior to retirement in case of disability.

(c) Life insurance.

(d) Accident and health insurance.

The regulation, however, states that retirement benefits and life insurance will be considered part of a single, separate program of interrelated contributions and benefits to the extent they are provided under retirement income, endowment or other contracts providing life insurance protection.

Example (7) of section 1.72-2(a)(3)(iv) of the regulations describes a situation in which a plan provided both retirement and death benefits through the purchase of individual retirement income contracts from an insurance company. Any distribution received by an employee under such a plan, whether attributable to one or more retirement income contracts and whether made directly from an insurance company to the employee or made through the trustee shall be considered as received under a single contract for the purposes of section 72 of the Code.

The facts of Example (8) of section 1.72-2(a)(3)(iv) of the regulations are similar to those with regard to Plan X prior to its 1978 amendment and change in funding method. In Example (8), the plan funded the death benefits and part of the retirement benefits by purchasing individual retirement contracts from an insurance company. The remaining part of the retirement benefits are to be paid out of a separate investment fund. Accordingly, the pension plan includes, with respect to each participant, two separate contracts for purposes of section 72 of the Code. The retirement income contract purchased by the trust for each participant is a separate program of interrelated contributions and benefits and all distributions attributable to such contact [sic] (whether made directly from the insurance company to the employee or made through the trustee) are considered as received under a single contract.

The facts submitted show that prior to the cashing out of the whole life insurance policies, Plan X's trust fund consisted of these policies and an auxiliary investment fund. However, after the redemption of the policies on October 5, 1978, and the investment of their proceeds in securities, the trust fund was composed only of securities. As the examples in the regulations indicate, the individual whole life insurance policies and the investment fund were two separate programs. But after the whole life insurance policies were redeemed and invested in securities, Plan X became a single program of interrelated contributions and benefits.

Accordingly, with respect to your first ruling request, we conclude that the entire employee benefit arrangement of interrelated contributions and benefits between the employee/participant and Company M as the trustee and plan administrator embodied in Plan X after the redemption of the whole life policies is a single contract for purposes of section 72 of the Code. However, please note that in conformity with Example 8 of section 1.72-2(a)(3)(iv) of the regulations, all benefits and distributions attributable to the redeemed whole life policies are, for purposes of section 72, considered as received under a single contract.

Section 72(a) of the Code provides, as a general rule, that gross income includes any amount received as an annuity under an annuity, endowment, or life insurance contract.

Section 72(b)(1) of the Code provides, in part, that gross income does not include that part of any amount received as an annuity which bears the same ratio to such amount as the investment in the contract bears to the expected return under the contract.

Section 72(m)(3) of the Code provides, in part, that any deductible contribution to a trust described in section 401(a) and exempt from tax under section 501(a), which has been used to purchase life insurance protection for a participant is includible in the gross income of the participant for the appropriate taxable year.

Section 1.72-8(a)(1) of the regulations provides that an employee's investment in an annuity contract includes those employer contributions to the benefit of an employee or his beneficiaries to the extent they were includible in the employee's gross income under subtitle A of the Code or prior income tax laws.

Section 1.72-16(b)(4) of the regulations, dealing with the treatment of the cost of life insurance protection, however, provides that the amount includible in the gross income of the employee under this paragraph shall be considered as premiums or other consideration paid or contributed by the employee only with respect to any benefits attributable to the contract (within the meaning of section 1.72-2(a)(3)) providing the life insurance protection.

Thus, this provision is authority for treating an individual's P.S. 58 costs under Plan X as consideration paid by the employee for the original life insurance contracts because these amounts were included in the employee's gross income. In addition, section 1.72-16(b)(1)(ii) of the regulations provides that the rules of that paragraph (relating to whether employee contributions constitute consideration for benefits received) apply whether the proceeds of the contract are payable directly or indirectly to the participant. Proceeds are considered indirectly payable to a participant, for this purpose, if they are paid to the plan's trustee, who then disburses them. Since, in the instant case, the proceeds of the redeemed policies were payable to Plan X's trustees to invest in securities so as to fund the plan benefits, they are thus paid indirectly to participants and the rules in the regulations apply as well as if Plan X distributions consisted of the life insurance contracts and the participants personally cashed in the contracts.

Accordingly, in response to your second, third and fourth ruling requests, we conclude as follows:

2. The portion of the employer contributions which was included in the gross income of Plan X's participants as P.S. 58 costs constitutes consideration paid for the "contract" by the participant for purposes of determining a participant's investment in the "contract."

3. Upon a distribution from Plan X with respect to a particular participant, the portion of such distribution representing a return of that participant's investment in the "contract" shall be received, tax free, by the distributee.

4. In completing Form 1099 for any year in which there is any distribution from Plan X with regard to a participant who was previously taxed on such portion of the distribution as P.S. 58 costs, the trustee shall indicate that such portion is a tax-free return of investment in the contract.

Please note that for purposes of the conclusions reached in ruling requests 3 and 4, section 1122(c) of the Tax Reform Act of 1986 has amended section 72(b) of the Code so that an individual whose annuity starting date is before January 1, 1987, must exclude the same percentage of each distribution from taxation no matter for how long annuity payments are received. An individual with a later annuity starting date, however, must stop excluding a portion of the distribution from taxation when the individual has recovered tax-free the actual amount of employee contributions.

This ruling is based upon the assumption that Plan X was and will be qualified under section 401(a) of the Code and its related trust was and will be exempt from tax under section 501(a) at all time relevant to this ruling request.

A copy of this ruling has been sent to your authorized representative in accordance with the power of attorney on file with this office.

Sincerely yours,

Allen Katz

Chief, Employee Plans

Rulings Branch

Enclosures:

Notice of Intention to Disclose

Deleted Copy of this letter

Written Determination

Number: 8843001

Internal Revenue Service

May 10, 1988

Symbol: E:EP:Q:8

Uniform Issue List No.: 0403.01-00

This letter is in response to a request for a private letter ruling dated December 2, 1987, submitted on your behalf by your authorized representative, and supplemented by subsequent letters, concerning the applicability of section 403(b) of the Internal Revenue Code to Annuity Contract X, issued by Company N, which will be purchased by Employer M for your benefit.

Your authorized representative submitted the following facts and representations:

You are a teacher employed by Employer M, an educational organization described in section 170(b)(1)(A)(ii) of the Code, which is a political subdivision of State A. Employer M proposes to establish an annuity program that satisfies the requirements of section 403(b) of the Code. Under the proposed arrangement, Employer M will purchase for you, certain annuity benefits as provided for in Annuity Contract X issued by Company N. Contract X provides for the accumulated annuity value to be distributed on the Contract's annuity starting date, no later than April 1 of the calendar year following the calendar year in which you attain the age of 70 and a half. During the period of time prior to the annuity starting date, the policy is designed to offer certain death benefits. Under the proposed arrangement, you will have possession of Annuity Contract X and pursuant to the terms of said contract you will be the owner of Annuity Contract X.

Ruling Request 4:

That the net term cost of the life insurance determined pursuant to Table PS-58 or Company N's rates for individual one year term policies, if lower, is includible in your gross income.

Analysis:

Under section 1.72-16(b) of the Regulations, when employer contributions to a tax-qualified annuity plan are used to purchase life insurance coverage for a participant employee, the portion of the contribution allocable to the pure cost of the insurance protection (the term cost) is treated as a distribution and results in the current recognition of gross income.

In accordance with Revenue Ruling 66-110, 1966-1 C.B. 12, you may calculate the amount of income to be recognized in accordance with the "P.S. 58 rates" as published in Revenue Ruling 55-747, 1955-2 C.B. 228, or, if the actual premiums paid for the pure insurance coverage are shown to be less than the "P.S. 58 rates" the actual premiums may be used.

Accordingly, we conclude that the net term cost of the life insurance protection is determined in accordance with the "P.S. 58 rates", or Company N's rates for individual one year term policies, if lower, pursuant to Rev. Rul. 55-747 and Rev. Rul. 66-110 and is includible in your gross income within the meaning of section 1.72-16(b) of the Regulations.

Private Letter Ruling

Number: 9007001

Internal Revenue Service

September 8, 1989

Symbol: E:EP:R:9

Uniform Issue List Nos.: 0403.00-00, 6047.00-00

This is in response to your ruling request dated May 24, 1988, as supplemented and amended by your letters dated July 11, 1988, August 5, 1988, August 29, 1988, May 1, 1989 and May 3, 1989, which were submitted on your behalf by your authorized representative. The ruling request concerns the federal income tax reporting requirements of Insurance Company M resulting from its proposal to provide life insurance as part of an Internal Revenue Code section 403(b) group annuity contract.

Your authorized representative submitted the following facts and representations:

Insurance Company M is the issuer of a group annuity contract. This group annuity contract is used by Company N, an association made up of employers described in section 501(c)(3) of the Internal Revenue Code who are exempt from tax under section 501(a), to fund retirement arrangements adopted by these employers. These retirement arrangements are intended to satisfy the requirements of section 403(b).

Insurance Company M has proposed to amend the group annuity contract to provide that (1) employee-participants may direct that an appropriately restricted percentage of their annual contributions to the annuity contract be used to pay premiums upon either a whole life insurance policy or a term life insurance policy, (2) contracts upon a participant's life will be converted to cash, an annuity, or distributed to the participant at the participant's annuity starting date, and (3) for purposes of the incidental insurance provisions, ordinary life insurance contracts are contracts with both nondecreasing death benefits and nonincreasing premiums.

Ruling Request:

Assuming these retirement arrangements satisfy the requirements of section 403(b) of the Code, and that amounts invested in the whole life insurance policy or term life insurance policy are deemed distributed or made available to participants under sections 1.403(b)-1(c)(3) and 1.72-16(b) of the Income Tax Regulations, such amounts shall be reported by Insurance Company M in accordance with Code section 6047(d)(1)(B) and the "PS 58" rules of Revenue Ruling 55-747, 1955-2 C.B. 228.

Analysis:

Section 1.72-16(b)(3) of the regulations provides, generally, that the cost of life insurance protection is included in the gross income of the participant for the taxable year or years in which such amounts are used to purchase life insurance. The cost of such life insurance protection is considered to be a reasonable net premium cost, as determined by the Commissioner, for such amount of insurance for the appropriate period.

Rev. Rul. 55-747, provides a table of uniform one-year premiums per $1,000 of term insurance ("PS 58" costs) which may be used to calculate the cost of current life insurance protection being provided to an employee under a life or endowment insurance contract held by an employees' trust qualified under Code section 401(a). Under section 1.72-16(b)(3) of the regulations, this cost is then includible in the gross income of the employee.

Section 6047(d)(1) of the Code provides that the secretary shall by forms or regulations require that the employer maintaining, or the plan administrator (within the meaning of section 414(g)) of, a plan from which designated distributions (as defined in section 3405(d)(1)) may be made, and any person issuing any contract under which designated distributions (as so defined) may be made, make returns and reports regarding such plan (or contract) to the Secretary, to the participants and beneficiaries of such plan (or contract) and to such other persons as the Secretary may prescribe.

When "PS 58" costs are Includible in the income of employees for whom life insurance protection is being provided pursuant to regulation section 1.72-16, these "PS-58" costs are deemed distributions under an annuity contract described in section 403(b)(1) of the Code. Consequently, such deemed distributions are designated distributions within the definition in section 3405. These deemed distributions, representing the "PS 58" costs, are then reported in accordance with the reporting requirements in section 6047(d) and section 35.3405-1T of the temporary regulations.

Insurance Company M, as issuer of the group annuity contract under which the deemed distributions are being made, is responsible for reporting the "PS 58" costs on Form W-2P in accordance with section 6047(d) and Q&As E-8 and E-9 of section 35.3405-1T of the temporary regulations. Accordingly, we conclude that, assuming these retirement arrangements satisfy the requirements of section 403(b) of the Code and amounts invested in the whole life insurance policy or term life insurance policy are deemed distributed or made available to participants under sections 1.403(b)-1(c)(3) and 1.72-16(b) of the Income Tax Regulations, such amounts shall be reported by Insurance Company M in accordance with Code section 6047(d)(1)(B) and the "PS 58" rules of Rev. Rul. 55-747.

Private Letter Ruling

Number: 9023044

Internal Revenue Service

March 9, 1990

Symbol: E:EP:R:10

Uniform Issue List No.: 0072.00-00

This is in response to a ruling request dated ***** concerning the income tax consequences of the purchase of life insurance and riders on the lives of participants and their dependents according to the terms of Plan X.

The rulings are based on the following representations:

Company M maintains Plan X, a profit sharing plan for the benefit of certain of its employees. Plan X, which includes a cash or deferred arrangement, (CODA), feature is qualified under section 401(a) of the Internal Revenue Code.

Plan X permits a participant to direct the plan administrator to use a limited portion of Plan X contributions to purchase life insurance. You represent that Plan X permits the purchase of life insurance, limited under the incidental death benefit rule as it is applied to qualified plans. A proposed amendment to Plan X permits a participant to direct the plan administrator to purchase a policy with certain riders within the incidental benefit rule limitations.

You represent that Plan X permits an ordinary whole life policy of insurance to be issued on the life of a plan participant and owned by the plan trustee. The policy is purchased by the plan administrator only at the direction of the plan participant. Further, under Plan X as amended, at the election of the participant, the plan administrator would also obtain the plan participant's spouse's rider, or the child's rider, or both, to be made a part of the insurance policy purchased on the participant's life. The spouse's insurance rider and the child's rider would be in the form of term-type coverages.

Upon the death of the covered spouse or dependent child, a death benefit would be payable to the participant. The trustee would be required to pay the death benefit to the participant, or to accumulate such death benefit in the participant's individual account under Plan X, at the plan participant's direction. The plan trustee would not be able to exercise any option regarding the disposition of the proceeds of the insurance, or the riders.

Ruling Request 1:

The cost of the insurance provided by each dependent coverage rider, which cost is currently includible in the participant's income, may be measured by the actual cost of such rider.

Analysis:

Section 72(m)(3) of the Code and section 1.72-16(b) of the Income Tax Regulations govern the treatment of the cost of life insurance purchased by a trust described in section 401(a) which is exempt from tax under section 501(a), if the proceeds of such contract are payable directly to a participant, his beneficiary, or to the trustee for the benefit of the participant or his beneficiary. If amounts which were allowed as a deduction under section 404 or earnings of the trust are applied toward the purchase of a life insurance contract, the cost of the life insurance protection under such contract shall be included in the gross income of the participant for the taxable year(s) in which such contributions or earnings are so applied. However, if the amount payable upon death at any time during the year exceeds the cash value of the insurance policy at the end of the year, the entire amount of such excess is considered current life insurance protection. The cost of such insurance will be considered to be a reasonable net premium cost, as determined by the Commissioner, for such amount of insurance for the appropriate period.

Section 1.72-16(b)(1)(ii) of the regulations provides that the proceeds of a life insurance contract purchased by a qualified and tax-exempt employees' trust will be considered payable indirectly to a participant or his beneficiary where they are payable to the trustee if, under the terms of the plan, the trustee is required to pay over all of such proceeds to the beneficiary. In the instant case, the proceeds of any insurance policy on the life of a spouse, or child are payable directly to the participant, or accumulate in the participant's individual account under Plan X, at the participant's direction, for distribution at a later date.

Revenue Ruling 55-747, 1955-2 C.B. 228, sets forth the bases upon which one-year term premiums may be computed for use in determining the amount required to be included in the income of an employee on account of current life insurance protection provided for such employee under a life or an endowment insurance contract held by an employees' trust qualified under section 401(a) of the Code. Factors for ages not shown in Rev. Rul. 55-747 must be consistent with the factors set forth in that Revenue Ruling.

Revenue Ruling 66-110, 1966-1 C.B. 12, which amplifies Rev. Rul. 55-747 states, in part, that current published premium rates charged by an insurer for individual one-year term life insurance available to all standard risks may be used for determining the cost of insurance in connection with individual policies issued by the same insurer and held by trusts qualified under section 401(a) of the Code where those rates are lower than the rates set forth in Rev. Rul. 55-747.

In the instant matter, the rider is only available at the election of the plan participant, as part of the policy purchased on the life of the participant. As such, the criteria established in Rul. 66-110 has not been met. Therefore, that Rev. Rul. is not applicable.

Accordingly, in regard to your first ruling request, we conclude that the cost of such insurance is includible in the gross income of the participant in the year(s) in which employer contributions to Plan X, or the earnings thereon, are applied to such purchase. The cost of the insurance currently included in the participant's income may not be measured by the actual cost of the rider, but measured by the standards as described under Rev. Rul. 55-747.

Ruling Request 3:

With respect to each rider separately, distribution of insurance proceeds by the trustee to the participant upon death of the participant's spouse or child will be treated as life insurance proceeds exempt from income tax under section 101(a) of the Code, and not subject to the distribution restrictions applicable to salary deferral contributions under section 401(k).

Analysis:

With regard to ruling requests three and five, section 72(m)(3)(C) of the Code provides that in the case of the death of an individual insured under a contract purchased by a trust described in section 401(a) of the Code which is exempt from tax under section 501(a), if the proceeds of such contract are payable directly or indirectly to a participant in such trust or to a beneficiary of such participant, an amount equal to the cash surrender value of the contract immediately before the death of the insured shall be treated as a payment under such plan or a distribution by such trust, and the excess of the amount payable by the death of the insured over such cash surrender value shall not be included in gross income under this section and shall be treated as provided in section 101, relating to the treatment of death benefits.

Accordingly, with regard to ruling request three, we conclude that the distribution of any excess insurance proceeds over the cash surrender value of the contract determined as of the date immediately prior to the death of an individual insured under the provisions of Plan X will be treated as a distribution of insurance proceeds under section 101(a) rather than as a distribution from a qualified plan.

Private Letter Ruling

Number: 9324042

Internal Revenue Service

March 25, 1993

Symbol: E:EP:R:5

Uniform Issue List No.: 0403.04-04

This letter is in response to your ruling request dated August 19, 1992, and as supplemented by correspondence dated November 16, December 15, and 18, 1992, March 11, and 23, 1993, submitted on your behalf by your authorized representative concerning the Federal income tax consequences of an election to purchase life insurance contracts as part of an annuity arrangement under section 403(b) of the Internal Revenue Code.

The following facts and representations have been submitted:

Employer A is an employer described in section 501(c)(3) of the Code which is exempt from tax under section 501(a) of the Code. Employer A currently sponsors an annuity arrangement to provide retirement benefits for its employees. Employer A's annuity arrangement meets the formal requirements of and therefore qualifies under section 403(b) of the Code. Under Employer A's section 403(b) annuity arrangement, individual section 403(b) annuities are purchased for participating employees with amounts contributed pursuant to salary reduction agreements. Currently, the annuity contracts purchased pursuant to Employer A's section 403(b) annuity arrangement are issued by Company a and other life insurance companies. In order to offer Individual A a greater degree of flexibility in selecting benefit options, Employer A proposes that Individual A be allowed to use part of the contributions under his section 403(b) annuity contracts to provide incidental death benefits in connection with such annuity contracts through the purchase of life insurance contracts issued by Company B.

It is contemplated that Individual A, a participant in Employer A's section 403(b) annuity arrangement, would be allowed to use contributions consisting of salary reduction amounts to purchase Contract C, a flexible premium life insurance contract, issued by Company B to provide incidental death benefits. Individual A would be allowed to direct that current contributions to the section 403(b) annuity contract, as well as contributions already accumulated thereunder, be used to purchase Contract C issued by Company B, within limits applicable to the type of life insurance coverage purchased under the incidental benefit rule of section 1.403(b)-1(c)(3) of the Income Tax Regulations and relevant revenue rulings thereunder.

Ruling Request 2:

The use by Individual A, as participant, of current as well as accumulated contributions under a section 403(b) annuity contract pursuant to Employer A's section 403(b) annuity arrangement to purchase Contract C issued by Company B to provide incidental death benefits, within the limits applicable to the type of life insurance coverage purchased, as specified in Endorsement D, would not give rise to currently taxable income to the owner of the annuity (except to the extent that the cost of current life insurance protection is includible in the income of the annuity owner under sections 1.72-16(b) and 1.403(b)-1(c)(3) of the regulations).

Analysis:

Under section 1.403(b)-1(b)(4) of the regulations, a section 403(b) annuity contract pursuant to Employer A's section 403(b) annuity arrangement and a life insurance contract issued by Company B purchased to provide incidental death benefits in connection with such annuity contract would be treated as a single section 403(b) annuity contract for purposes of section 403(b).

Section 1.403(b)-1(c)(3) of the regulations permits incidental life insurance protection to be purchased as part of a Code section 403(b) annuity contract. Section 1.72-16(b)(2) of the regulations provides that the cost of the life insurance protection under a life insurance contract shall be included in the gross income of the participant for the taxable year or years in which contributions or earnings are applied for the purchase of a life insurance contract.

Revenue Ruling 66-110, 1966-1 C.B. 12 amplifies Revenue Ruling 64-328, 1964-2 C.B. 11 and Revenue Ruling 55-747, 1955-2 C.B. 228 (which is the same as PS 58 Revised) and holds that the rates set forth in Rev. Rul. 55-747 (or the current published premium rates per $1,000 of insurance protection charged by such insurer for individual 1-year term life insurance available to all standard risks, if lower) may be used to determine the cost of current life insurance protection required to be included in the income of an employee who is furnished insurance protection under a trust qualified under section 401(a) of the Code. Such cost is includible in the employee's gross income in accordance with section 72(m)(3) of the Code.

Therefore, with respect to your second ruling request, we conclude that the use by Individual A, as participant, of current as well as accumulated contributions under a section 403(b) annuity contract pursuant to Employer A's section 403(b) annuity arrangement to purchase Contract C issued by Company B to provide incidental death benefits, within the limits applicable to the type of life insurance coverage purchased, as specified in Endorsement D, would not give rise to currently taxable income to the owner of the annuity (except to the extent that the cost of current life insurance protection is includible in the income of the annuity owner under sections 1.72-16(b) and 1.403(b)-1(c)(3) of the regulations).

Private Letter Ruling

Number: 9324043

Internal Revenue Service

March 26, 1993

Symbol: E:EP:R:5

Uniform Issue List No.: 0403.04-04

This letter is in response to your ruling request dated August 19, 1992, and as supplemented by correspondence dated November 16, December 15, 1992, March 11, and 23, 1993 submitted on your behalf by your authorized representative concerning the Federal income tax consequences of an election to purchase life insurance contracts as part of an annuity arrangement under section 403(b) of the Internal Revenue Code.

The following facts and representations have been submitted:

Employer A is an employer described in section 501(c)(3) of the Code which is exempt from tax under section 501(a) of the Code. Employer A currently sponsors an annuity arrangement to provide retirement benefits for its employees. Employer A's annuity arrangement meets the formal requirements of and therefore qualifies under section 403(b) of the Code. Under Employer A's section 403(b) annuity arrangement, individual section 403(b) annuities are purchased far Individual A, an employee of Employer A who participates in Employer A's annuity arrangement, with amounts contributed pursuant to a salary reduction arrangement. Currently, the annuity contracts purchased pursuant to Employer A's section 403(b) annuity arrangement are issued by Company B and other life insurance companies. In order to offer Individual A a greater degree of flexibility in selecting benefit options, Employer A proposes that Individual A be allowed to use part of the contributions under his section 403(b) annuity contracts to provide incidental death benefits in connection with such annuity contracts through the purchase of life insurance contracts issued by company B.

It is contemplated that Individual A, a participant in Employer A's section 403(b) annuity arrangement, would be allowed to use contributions consisting of salary reduction amounts to purchase Contract C, a flexible premium life insurance contract, issued by Company B to provide incidental death benefits. Individual A would be allowed to direct that current contributions to the section 403(b) annuity contract, as well as contributions already accumulated thereunder, be used to purchase Contract C issued by Company B, within limits applicable to the type of life insurance coverage purchased under the incidental benefit rule of section 1.403(b)-1(c)(3) of the Income Tax Regulations and relevant revenue rulings thereunder.

When Individual A elects to use his contributions under Employer A's section 403(b) annuity arrangement to purchase Contract C issued by Company B he will establish a trust (Trust Agreement D) and such life insurance contract will be held by the trustee of such trust. Under the terms of the trust agreement creating such trust, any life insurance contract which would be purchased to provide incidental death benefits in connection with a section 403(b) annuity under Employer A's section 403(b) annuity arrangement and which would be held in trust would be subject to the formal requirements and limitations of section 403(b).

Analysis:

Under section 1.403(b)-1(b)(4) of the regulations, a section 403(b) annuity contract pursuant to Employer A's section 403(b) annuity arrangement and a life insurance contract issued by Company B purchased to provide incidental death benefits in connection with such annuity contract would be treated as a single section 403(b) annuity contract for purposes of section 403(b).

Section 1.403(b)-1(c)(3) of the regulations permits incidental life insurance protection to be purchased as part of a Code section 403(b) annuity contract. Section 1.72-16(b)(2) of the regulations provides that the cost of the life insurance protection under a life insurance contract shall be included in the gross income of the participant for the taxable year or years in which contributions or earnings are applied for the purchase of a life insurance contract.

Revenue Ruling 66-110, 1966-1 C.B. 12, amplifies Revenue Ruling 64-328, 1964-2 C.B. 11, and Revenue Ruling 55-747, 1955-2 C.B. 228 (which is the same as PS 58 Revised), and holds that the rates set forth in Rev. Rul. 55-747 (or the current published premium rates per $1,000 of insurance protection charged by such insurer for individual 1-year term life insurance available to all standard risks, if lower) may be used to determine the cost of current life insurance protection required to be included in the income of an employee who is furnished insurance protection under a trust qualified under section 401(a) of the Code. Such cost is includible in the employee's gross income in accordance with section 72(m)(3) of the Code.

Therefore, with respect to your second ruling request, we conclude that the use by Individual A, as participant, of current as well as accumulated contributions under a section 403(b) annuity contract pursuant to Employer A's section 403(b) annuity arrangement to purchase Contract C issued by Company B to provide incidental death benefits, within the limits applicable to the type of life insurance coverage purchased, as specified in Trust Agreement D, would not give rise to currently taxable income to the owner of the annuity (except to the extent that the cost of current life insurance protection is includible in the income of the annuity owner under sections 1.72-16(b) and 1.403(b)-1(c)(3) of the regulations).

Private Letter Ruling

Number: 9324044

Internal Revenue Service

March 26, 1993

Symbol: E:EP:R:5

Uniform Issue List No.: 0403.04-04

This letter is in response to your ruling request dated August 19, 1992, and as supplemented by correspondence dated November 16, December 15, and 18, 1992, and March 11, 1993, submitted on your behalf by your authorized representative concerning the Federal income tax consequences of an election to purchase life insurance contracts as part of an annuity arrangement under section 403(b) of the Internal Revenue Code.

The following facts and representations have been submitted:

Employer A is a school district which is an agency of a state. Employer A currently sponsors an annuity arrangement to provide retirement benefits for its employees. Employer A's annuity arrangement meets the formal requirements of and therefore qualifies under section 403(b) of the Code. Under Employer A's section 403(b) annuity arrangement, individual section 403(b) annuities are purchased for participating employees with amounts contributed pursuant to salary reduction agreements. Currently, the annuity contracts purchased pursuant to Employer A's section 403(b) annuity arrangement are issued by Company B and other life insurance companies. In order to offer Individual A a greater degree of flexibility in selecting benefit options, Employer A proposes that Individual A be allowed to use part of the contributions under his section 403(b) annuity contracts to provide incidental death benefits in connection with such annuity contracts through the purchase of life insurance contracts issued by Company B.

It is contemplated that Individual A, a participant in Employer A's section 403(b) annuity arrangement, would be allowed to use contributions consisting of salary reduction amount to purchase Contract C, a flexible premium life insurance contract, issued by Company B to provide incidental death benefits. Individual A would be allowed to direct that current contributions to the section 403(b) annuity contract, as well as contributions already accumulated thereunder, be used to purchase Contract C issued by Company B, within limits applicable to the type of life insurance coverage purchased under the incidental benefit rule of section 1.403(b)-1(c)(3) of the Income Tax Regulations and relevant revenue rulings thereunder.

Analysis:

Under section 1.403(b)-1(b)(4) of the regulations, a section 403(b) annuity contract pursuant to Employer A's section 403(b) annuity arrangement and a life insurance contract issued by Company B purchased to provide incidental death benefits in connection with such annuity contract would be treated as a single section 403(b) annuity contract for purposes of section 403(b).

Section 1.403(b)-1(c)(3) of the regulations permits incidental life insurance protection to be purchased as part of a Code section 403(b) annuity contract. Section 1.72-16(b)(2) of the regulations provides that the cost of the life insurance protection under a life insurance contract shall be included in the gross income of the participant for the taxable year or years in which contributions or earnings are applied for the purchase of a life insurance contract.

Revenue Ruling 66-110, 1966-1 C.B. 12 amplifies Revenue Ruling 64-328, 1964-2 C.B. 11 and Revenue Ruling 55-747, 1955-2 C.B. 228 (which is the same as PS 58 Revised) and holds that the rates set forth in Rev. Rul. 55-747 (or the current published premium rates per $1,000 of insurance protection charged by such insurer for individual 1-year term life insurance available to all standard risks, if lower) may be used to determine the cost of current life insurance protection required to be included in the income of an employee who is furnished insurance protection under a trust qualified under section 401(a) of the Code. Such cost is includible in the employee's gross income in accordance with section 72(m)(3) of the Code.

Therefore, with respect to your second ruling request, we conclude that the use by Individual A, as participant, of current as well as accumulated contributions under a section 403(b) annuity contract pursuant to Employer A's section 403(b) annuity arrangement to purchase Contract C issued by Company B to provide incidental death benefits, within the limits applicable to the type of life insurance coverage purchased, as specified in Addendum D, would not give rise to currently taxable income to the owner of the annuity (except to the extent that the cost of current life insurance protection is includible in the income of the annuity owner under sections 1.72-16(b) and 1.403(b)-1(c)(3) of the regulations).

Private Letter Ruling

Number: 9617042

Internal Revenue Service

January 29, 1996

Uniform Issue List: 403.04-00

This is in response to your ruling request dated July 11, 1995, submitted by your authorized representative concerning the federal income tax consequences of an election to purchase a life insurance contract as part of an annuity program under section 403(b) of the Internal Revenue Code ("Code").

The following facts and representations have been submitted on your behalf:

You are employed by a school district, Employer M, which is treated as an educational organization described under section 170(b)(1)(A)(ii) of the Code. Employer M currently sponsors an annuity arrangement in order to provide retirement benefits for its employees. Employer M's annuity arrangement meets the formal requirements of section 403(b) of the Code. Under Employer M's section 403(b) annuity arrangement, annuity contracts are purchased for participating employees with amounts contributed pursuant to salary reduction agreements. You have entered into a salary reduction agreement with Employer M, pursuant to which Employer M purchased a section 403(b) annuity contract on your behalf.

You now propose to use part of current and accumulated contributions under your section 403(b) plan to obtain incidental death benefits through the purchase of Contract X, a level term life insurance contract. You may direct the investment of any portion of current or accumulated contributions to the purchase of Contract X provided that the aggregate of the premiums used for life insurance may be no more than 25% of the aggregate contributions allocated to you at any particular time. Contract X, issued by Company N, will be available for purchase under the section 403(b) program as a Level Term Life to Age 70 With Change of Premium Provision contract. Company N has made the representation that the life insurance contract meets the requirements of section 7702 of the Code and will qualify as a life insurance contract for tax purposes.

Ruling Request 2:

That the use by Individual A of current as well as accumulated contributions under a section 403(b) annuity contract pursuant to Employer M's section 403(b) annuity arrangement to purchase Contract X issued by Company N to provide incidental death benefits, within the limits applicable to the type of life insurance coverage purchased, as specified in the Endorsement to Contract X, will not give rise to currently taxable income to the owner of the annuity, except to the extent that the cost of current life insurance protection is includible in the income of the annuity owner under sections 1.72-16(b) and 1.403(b)-1(c)(3) of the regulations.

Analysis:

Under section 1.403(b)-1(b)(4) of the regulations, a section 403(b) annuity contract pursuant to Employer M's section 403(b) annuity arrangement and a life insurance contract issued by Company N purchased to provide incidental death benefits in connection with such annuity contract would be treated as a single section 403(b) annuity contract for purposes of section 403(b).

Section 1.403(b)-1(c)(3) of the regulations permits incidental life insurance protection to be purchased as part of a Code section 403(b) annuity contract. Section 1.72-16(b)(2) of the regulations provides that the cost of the life insurance protection under a life insurance contract shall be included in the gross income of the participant for the taxable year or years in which contributions or earnings are applied for the purchase of a life insurance contract.

Revenue Ruling 66-110, 1966-1 C.B. 12, amplifies Revenue Ruling 64-28, 1964-2 C.B. 11, and Revenue Ruling 55-747, 1955-2 C.B. 228 (which is the same as PS 58 Revised), and holds that the rates set forth in Rev. Rul. 55-747 (or the current published premium rates per $1,000 of insurance protection charged by such insurer for individual 1-year term life insurance available to all standard risks, if lower) may be used to determine the cost of current life insurance protection required to be included in the income of an employee who is furnished insurance protection under a trust qualified under section 401(a) of the Code. Such cost is includible in the employee's gross income in accordance with section 72(m)(3) of the Code.

Regarding your second ruling request, we conclude that the use by Individual A, as participant, of current as well as accumulated contributions under a section 403(b) annuity contract pursuant to Employer M's section 403(b) annuity arrangement to purchase Contract X issued by Company N to provide incidental death benefits, within the limits applicable to the type of life insurance coverage purchased, as specified in the Endorsement to Contract X, will not give rise to currently taxable income to Individual A, except to the extent that the cost of current life insurance protection is includible in the income of the annuity owner under sections 1.72-16(b) and 1.403(b)-1(c)(3) of the regulations.

Private Letter Ruling

Number: 9618028

Internal Revenue Service

February 6, 1996

Index Nos: 72.01-00, 72.07-02, 72.07-05

This is in response to the letter dated ***** submitted by your authorized representative, as supplemented by correspondence dated ***** and ***** in which you request letter rulings under section 72 of the Internal Revenue Code. The following facts and representations support your ruling request.

Taxpayer A was born on ***** and died on *****, survived by his spouse Taxpayer B. Taxpayer B's date of birth is *****. At the time of his death, Taxpayer A was a participant and had an account in Plan X, a defined contribution plan of the money purchase type. His vested Plan X account balance consisted of employer contributions, amounts held in his Plan X Rollover Account, and a life insurance policy issued by company C which insured the life of Taxpayer A. Article 17.7 of Plan X provides, in pertinent part, that the trustee of Plan X owns all insurance held for a participant.

The proceeds of the insurance policy on Taxpayer A's life payable to Plan X upon Taxpayer A's death totalled ***** of which the "net death benefit," defined as the amount or proceeds in excess of the cash value under the policy, totalled $*****. Your authorized representative has asserted that assets of Plan X were the source of funds for the insurance policy held on Taxpayer A's life, and that Taxpayer A reported his "PS-58" costs as income on an annual basis.

Article 16.1 of Plan X provides that any amount in a participant's account at his death becomes payable to his beneficiary. This amount includes the proceeds payable on account of the participant's death under any insurance or annuities in effect under the Plan. Taxpayer B is the sole beneficiary of Taxpayer A's Plan X account balance.

As of the date of Taxpayer A's death, he had not begun to receive distributions from Plan X. Article 14.15 of Plan X provides, in pertinent part, that if a participant dies before distributions have begun, distributions to a spouse who is the deceased's designated beneficiary may be made over her life (or over a period certain not greater that her life expectancy), and must begin no later than the end of the year in which the participant would have reached age 70 1/2.

During 1994, after the death of Taxpayer A, Company C paid to the trustees of Plan X all amounts due under the policy it had issued on Taxpayer A's life. The life insurance proceeds were then added to all other amounts standing in Taxpayer A's Plan X account at his death and the total amount was invested with Company D in bonds and equity funds. Your authorized representative has asserted that the Plan X amounts payable to Taxpayer B because of the death of Taxpayer A were not segregated at the time of investment, and have never been segregated since that date. He has also asserted that no individual Company D investment was purchased with a distinct part of Taxpayer A's Plan X account.

Beginning in 1995, Taxpayer B proposes to receive a yearly $100,000 distribution from Plan X over her life expectancy. Said distribution stream will be funded from Taxpayer A's Plan X account balance.

Ruling Request 2:

Taxpayer A's (and therefore Taxpayer B's) investment in Plan X for purposes of Code section 72(e)(6) includes his PS-58 costs, and the "net death benefit" (the amount in excess of the cash surrender value) payable under the Company C policy issued on the life of Taxpayer A.

Analysis:

With respect to your ruling requests, Code section 402(a) 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 taxable year of the distributee in which distributed, under section 72 (relating to annuities).

Code section 72(e)(6) provides that, for purposes of subsection 72(e), the investment in the contract as of any date is (A) the aggregate amount of premiums or other consideration paid for the contract before such date, minus (B) the aggregate amount received under the contract before such date, to the extent that such amount was excludable from gross income under this subtitle or prior income tax laws.

Section 1.72-16(b)(1)(ii) of the regulations provides that the rules of this paragraph are applicable to any life insurance contract purchased by a trust described in section 401(a) which is exempt from tax under section 501(a) if the proceeds of such contract are payable directly or indirectly to a participant in such trust or to a beneficiary of such participant. This sections adds that the proceeds of a contract described in subdivision (ii) of this subparagraph will be considered payable indirectly to a participant or a beneficiary of such participant where they are payable to the trustee but under the terms of the plan the trustee is required to pay over all of such proceeds to the beneficiary.

Section 1.72-16(b)(4) of the regulations, which deals with the treatment of the cost of life insurance protection, provides that the amount includible in the gross income of the employee under this paragraph shall be considered as premiums or other consideration paid or contributed by the employee only with respect to any benefits attributable to the contract (within the meaning of section 1.72-2(a)(3)) providing the life insurance protection.

Sections 1.72-16(c)(1) and (c)(2)(ii) of the regulations provide, in pertinent part, that if a qualified retirement plan purchases a life insurance contract, and the employee either pays the cost of the contract or is taxed on its cost (P.S. 58 costs), then the portion of the proceeds paid upon the death of the insured employee which is equal to the cash surrender value immediately before death is not excludable from gross income under section 101(a). The remaining portion, if any, of the proceeds paid to the beneficiary by reason of the death of the insured employee—that is, the amount in excess of the cash surrender value—constitutes current insurance protection and is excludable under section 101(a).

In this case, Taxpayer B intends to receive a yearly distribution from Plan X in the amount of $100,000 beginning in 1995 and extending over her life expectancy. We conclude that such distributions do not constitute "amounts received as an annuity" within the meaning of Code section 72(b)(1) and section 1.72-2(b)(2) of the regulations. Furthermore, we conclude that, in the absence of annuity payments, there is no "annuity starting date" with respect to Taxpayer B's distributions from Plan X.

With respect to your second ruling request, in this case, the insurance proceeds from the policy issued by Company C on the life of Taxpayer A were used to partially fund the distributions to Taxpayer B from Plan X. Taxpayer A was taxed on the "PS-58" costs which provided the insurance coverage on his life. Accordingly, under the above Code and regulation provisions, the "PS-58" costs constitute "investment in the contract" within the meaning of Code section 72(e)(6). Additionally, under the facts presented in this case, the "net death benefit" (the amount in excess of the cash surrender value) payable under the Company C policy issued on the life of Taxpayer A to Taxpayer B may be treated as "investment in the contract" within the meaning of Code section 72(e)(6).

Thus, with respect to your second ruling request, we conclude as follows:

2. Taxpayer A's (and therefore Taxpayer B's) investment in Plan X includes his PS-58 costs, and the "net death benefit" (the amount in excess of the cash surrender value) payable under the Company C policy issued on the life of Taxpayer A.