Rev. Rul. 55-298

Advice has requested (1) whether an employee is in receipt of gross income as a result of the purchase for him of an annuity contract (as distinguished from a contract containing an element of life insurance) by the trustees under a profit-sharing plan which meets the requirements of section 165(a) of the Internal Revenue Code of 1939, where the employee's rights under the contract are fully vested at the time of the purchase; (2) whether the `long term capital gain treatment' provided in section 165(b) of the Code is accorded where the contract is distributed to the employee (or his beneficiary) by reason of the termination of his services and, in a year subsequent to that in which such distribution is made, the contract is surrendered for its cash value; (3) whether such `long term capital gain treatment' is accorded if the contract is surrendered for its cash value in the year in which distributed to him (or his beneficiary); and (4) whether the phrase `within one taxable year' contained in section 165(b) of the Code implies that the total distributions payable from a trust exempt under section 165(a) of the Code must be made in the year in which the employee's services are terminated in order to obtain the `long term capital gain treatment.'

The profit-sharing plan of the M company has been held to meet the requirements of section 165(a) of the Code. Contributions to the trust by the employer are allocated among the participants in accordance with a nondiscriminatory formula and are used to pay premiums under a group annuity contract of the money purchase type, whereby paid-up deferred annuities are purchased for covered employees each year the company makes a contribution to the trust. The rights of each of the participants to the benefits provided for him under the contract are fully vested at the time of purchase (premium payment), except the right to surrender for cash in the event of termination of services within 10 years prior to normal retirement date. If termination of service occurs more than 10 years prior to normal retirement date, the paid-up deferred annuities provided for his benefit will be transferred to the participant, who may surrender them at any time for the cash surrender value thereof. The trustee has no power to cancel or surrender annuities once they are purchased, except he may surrender a participant's annuities for cash upon the participant's termination of service other than by retirement or death.

Section 39.165-6(a)(2) of Regulations 118 provides that, if a trust exempt under section 165(a) of the Code purchases an annuity contract for an employee and distributes it to the employee in a year for which the trust is exempt, the contract containing a cash surrender value which may be available to the employee by surrendering the contract, such cash surrender value will not be considered income to the employee unless and until the contract is surrendered.

Section 165(b) of the Code provides that if a trust exempt under section 165(a) of the Code pays to a distributee within one taxable year of the distributee the total distributions payable with respect to the employee, on account of the employee's separation from the service, the amount of such distribution, to the extent it exceeds the amounts contributed by the employee, shall be considered a gain from the sale or exchange of a capital asset held for more than 6 months.

Accordingly, where a trust, exempt under the provisions of section 165(a) of the Code, purchases an annuity contract (as distinguished from a contract containing an element of life insurance) for a participating employee, such employee is not in receipt of gross income by reason of such purchase, even though the employee has a vested interest in the contract at the time of purchase or the trustee has a limited control over the contract. Neither is the employee (or his beneficiary) in receipt of gross income in the taxable year in which such contract is distributed to him, by reason of such distribution, but is taxable when the contract is surrendered.

Since section 165(b) of the Code provides that the amounts distributed or made available to any distributee of a trust exempt under section 165(a) of the Code shall be taxable to him in the year in which so distributed or made available, ans since the `long term capital gain treatment' is accorded only where the `total distributions payable' are paid in one year by reason of the employee's separation from the service, such `long term capital gain treatment' is not applicable to a year subsequent to the year of distribution of the contract. Furthermore, the proceeds of the annuity contract surrendered in a year subsequent to its distribution by the trust are not paid `on account of the employee's separation from the service.'

Where (1) the `total distributions payable,' with respect to an employee participating in a trust exempt under section 165(a) of the Code, are distributed to a distributee (employee or his beneficiary) on account of the employee's separation from the service, (2) such `distributions payable' are in the form of an annuity contract, and (3) the distributee surrenders the annuity contract for its cash value during the taxable year in which the contract is distributed to him, then the deferment of taxation permitted by section 39.165-6(a)(2) of Regulations 118, is not applicable, but the distribution, represented by the proceeds of the annuity contract, is treated as a long term capital gain, since surrender of the contract during the year of its receipt from the trust has the same effect as a distribution by the trust in the form of cash