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NUA and lump sum distributions


Guest Learner

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Guest Learner

Can someone take only dividends as distributions from their 401(k) after they turn 55 and have separated from service without taking away their ability to do an NUA transaction on the rest of the stock? Thanks in advance for your help on this.

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Learner - An ESOP participant is eligible to exclude NUA from income if the distribution is part of a lump-sum distribution. Section 402(e)(4)(D) generally defines a lump-sum distribution from an employer plan as the entire balance to the credit of the account made within a single calendar year on account of death, following age 59 1/2 or on account of separation from service.

So, if dividends were distributed upon termination of employment and the rest of the value was distributed before the end of the year, you would still get a lump-sum distribution. Otherwise, you need to look at the facts. There is little guidance here except for hundreds of private letter rulings that were issued prior to the 1986 change in the lump-sum distribution tax rules. In general, under the interpretations expressed in those rulings, an individual could take a partial distribution for one reason - separation from service and then take the remainder of their account for another reason - death, following age 59 1/2 and qualify for lump-sum treatment on the following distribution. BUT, this is law by letter ruling which is not all that reliable. Thus, you need to do some research to see what kind of comfort you can get for your client.

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NUA is available to any participant who who receives employer stock in a lump sum distribution, i.e., the balance to the employee's credit under the plan in 1 taxable year in a distributable event. Withdrawals prior to the year the lump sum is taken do not effect the lump sum distribution in a later year in which the balance to the credit of the employee is received. PLR 200315041.

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Guest Harry O

ESOP dividend distributions are not treated as part of the "balance to the credit" of the employee. Thus, the distribution of deductible dividends do not prevent a later distribution of the balance to the credit of the employee from being a lump sum distribution. See, e.g., PLR 9024083.

mjb - Prior distributions certainly can impact whether a subsequent distribution is a qualifying lump sum. The basic test is that the first distribution after a "triggering" event -- e.g., termination of employment or attainment of age 59.5 -- must be a complete distribution of the balance to the employee's credit in one taxable year. For example, assume an employee separates from service at age 58. She takes no distributions from the plan until age 60 when she takes a $1,000 withdraw. In the next year when she is age 61 she takes a complete withdrawal. This complete withdrawal at age 61 is NOT a lump sum distribution because the first distribution following a triggering event (separation from service or attainment of age 59.5 was NOT a complete distribution). Note that had she taken the $1,000 payment when she was age 58 and then took the complete distribution at age 61, the complete distribution at age 61 would be a qualifying lump sum. This is because the first distribution following a triggering event - in this case, attainment of age 59.5 - was a complete distribution within one taxable year. So what happens in prior years can very often impact the tax treatment of a distribution in subsequent years.

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I dont think that is the law. The only requirement under IRC 402(e) is that the participant must receive the balance to the credit of his account in the year NUA is elected. Wiithdrawals in prior years are not the part of the balance. The PLR I cited permitted NUA treatment where the participant had taked periodic payments under 72t in prior tax years. Since there is nothing in IRC 402(e) that says that the LS treatment is permitted only for the initial distribution from the plan I dont see how the IRS could add this requirement in a PLR the absence of a regulation. I dont know if there is a different answer in the instructions to Form 4972.

In your example the trigging event is separation from service, not attainment of 59 1/2.

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Guest Harry O

mjb -

You must have missed class the day they covered lump sum distributions.<g>

First, PLR 200315041 is entirely consistent with my post. The employee terminated at age 52, commenced installment payments at age 55 and was proposing to take a final lump sum from the plan after he attained age 59.5. His first triggering event was termination of employment at age 52. The first distribution he received after this triggering event was not a lump sum, it was an installment payment at age 55. But luckily for our employee, he still has one more potential triggering event left: attainment of age 59.5. If the first distribution he receives after that date is a lump sum, that amount will be a qualified lump sum. The IRS ruled accordingly (no surprise).

Your theory would say that the employee could have elected a lump sum at age 58, three years after he commenced installment payments. This would clearly not be a lump sum since the only triggering event to that date was separation from service at age 52 and, unfortunately, his first distribution after that date was installment payments at age 55 rather than a single sum. I suspect our taxpayer in PLR 200315041 would have received an entirely different response if he told the IRS he was taking his final payment at age 58! Your statement that prior distributions do not impact whether a subsequent lump sum is an eligible lump sum is true only if there is a new triggering event after the prior payments started (age 59.5 in the PLR you cited) and the subsequent lump sum is the first payment after such new triggering event.

There are scores of PLRs to this effect. There are proposed regulations to this effect (dating back to just after ERISA). Moreover, there are numerous pre-ERISA authorities to this effect (see, e.g., Rev. Rul. 69-495). There really is no room for debate on this point. Now whether plan administrators and the Vanguards and Fidelities of the world properly report these payments is another matter . . .

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I dont understand how you can say there is nothing to debate when neither IRC 402(e)(4) nor the instructions to electing lump sum treatment for NUA on the 4972 form P 3, provide authority for your conclusion. (A lump sum is defined in the 4972 instructions as the distribution of the participant's entire balance from all plans of the same type in one taxable year.) The PLRs arent authority for whether another taxpayer can elect NUA. (Sometimes it better not to ask for a ruling and rely on statutory language in your favor.) The proposed regs are not authority because the statutory langauge has been revised (which is why the regs have not been made final). If the IRS had authority to limit the definition of a lump sum as you believe the 69 ruling requires they would have included it in the 4972 instructions which defines other types of distributions not eligible for lump sum treatment. You also miss the point of tax reporting by payors - it is the taxpayer's responsibilty to report the election of NUA by filing a 4972 form not the payor's responsibility- the payor will report that a lump sum distribution as defined in IRC 402(e) was paid and the taxpayer then determines the tax treatment of the stock.

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Guest Harry O

First you cite a PLR to support your position when it in fact supports mine. Now you tell me that PLRs are worthless and instead refer to instructions on IRS forms! There is over 35 years of IRS guidance that contradicts your position. The statutory language, in my opinion, seems to support the IRS.

You missed my point on reporting by payors. If the payor reports the distribution (erroneously) as a qualifying lump sum, it is extremely unlikely that the IRS will even investigate whether this characterization is correct. Obviously a taxpayer makes the final call on how to report something on his or her tax return.

Unless you can provide me with one case, regulation, ruling, or utterance by someone who agrees with you, we will have to agree to disagree.

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I cited the ruling to demonstrate that distributions made prior to the date of an LSD do not prohibit a participant from electing NUA at a later date as a lump sum distribution, not that PLRs issued under one set of facts are law that can be cited as contrary authority by the IRS against against other taxpayers. If ,as you believe, the statutory language supports 35 yrs of IRS guidance why isnt this position stated in the 4972 instructions along with the other distributions that are not eligible for lump sum status under the statute? Given that the statutory language and the instructions in the 4972 form permit an NUA election how can a taxpayer be penalized for electing NUA?

Could you explain what risk a taxpayer takes by following the instructions in the 4972 form in electing NUA when none of the authorities you cited can be used to contradict that election. What authority can the IRS cite to contradict its own instructions to taxpayers?

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Guest Harry O

mjb -

You are probably a pretty good attorney since you have mastered the art of simply repeating your position each posting, only a bit more forcefully than before. You also post citations to authorities that often don't necessarily stand for the proposition you cite them for (see, e.g., PLR 200315041). Nevertheless, I enjoy your posts and often learn something new.

That said, I have posted sample citations to authority that clearly supports my point. I could do a famous string cite here since there are *numerous* PLRs to this end.

I also don't think the statute supports your position.

Finally, are you really serious that because summary instructions to an IRS form don't expressly address a certain position that means it must be o.k.? I didn't think so . . .

Would you give a "more likely than not" opinion to a client that he can treat such a payment as a lump sum? If so, I say "good luck" . . . and check the coverage on your malpractice insurance! <g>

We'll have to agree to disagree.

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If the IRS believes (as you think it does) that prior distributions will prevent a lump sum election for 10 yr forward averaging as well as NUA, why havent final regulations been issued in the 31 years since the prop. regs were issued on 4/30/75? (Just what part of "balance to the credit of the account in one taxable year" in IRC 402(e)(4) does not apply since balance obviously refers to whatever amount is in the account in the year of the total distribution.) Your position is no different than that of an IRS agent who when asked for the authority for denying NUA to a taxpayer who took withdrawals in prior years (including distributions of NUA attributable to after tax employee contributions which do not require an LSD under IRC 402(e)) responds "based on 35 years of private letter rulings that cannot be cited against you as precedent and proposed regulations that have never been finalized as intrepretative law as required under the APA."

ciao.

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Just to clarify on Harry O's reference to PLR 9024083 - this is limited to dividends that are being distributed pursuant to IRC Section 404(k). I made an implicit assumption - that I should have made explicit - that you were taking about dividends which had been accumulated in the trust for a number of years. Such dividends would not be 404(k) dividends and my response stands. If, however, we are talking about a current dividend distribution from a C corporation, the PLR addresses the arguments.

Sorry for not making my assumption more obvious.

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Becky: The ruling has one glaring flaw. It cites IRC 402(e)(4)(A) for the premise that a triggering event occurred when the first distribution of stock was made and not when the balance in the account was paid upon retirement. However, there is nothing in the cited code section that contains such a statement. The only place where the cited language appears is in prop. reg 1.402-1(e) which the IRS could not cite because it not authority under the tax law. The IRS essentially made up a reason to deny lump sum treatment using a reference that is not binding authority (This is another reason why you need to read PLRs and other IRS opinions to determine if the law actually provides for such a conclusion.) If the other rulings on this issue use the language of the prop reg as authority under the statute they are worthless (as well as not applicable against other taxpayers).

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  • 4 months later...
Guest Harry O

See just issued PLR 200634059 (second ruling request) for confirmation that prior distributions can cause a subsequent single sum distribution to NOT qualify as a lump sum eligible for NUA.

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