[Code of Federal Regulations]
[Title 26, Volume 5]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.403(a)-2]

[Page 409-410]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.403(a)-2  Capital gains treatment for certain distributions.

    (a) If the total amounts payable with respect to any employee for 
whom an annuity contract has been purchased by an employer under a plan 
which--
    (1) Is a plan described in section 403(a)(1) and Sec. 1.403(a)-1, 
and
    (2) Requires that refunds of contributions with respect to annuity 
contracts purchased under such plan be used to reduce subsequent 
premiums on the contracts under the plan,

are paid to, or includible in gross income of, the payee within one 
taxable year of the payee by reason of the employee's death or other 
separation from the service, or death after such separation from the 
service, such total payments, to the extent they exceed the net amount 
contributed by the employee, shall be considered a gain from the sale or 
exchange of a capital asset held for more than six months. The ``net 
amount contributed by the employee'' is the amount actually contributed 
by the employee plus any amounts considered to be contributed by the 
employee under the rules of sections 72(f), 101(b), and paragraph (d) of 
Sec. 1.403(a)-1, reduced by any amounts theretofore distributed to him 
which were excludable from his gross income as a return of employee 
contributions. For example, if under an annuity contract purchased under 
a plan described in this section, the total distributions payable to the 
employee's widow are paid to her in the year in which the employee dies, 
in the amount of $8,000, and if $5,000 thereof is excludable under 
section 101(b), and if the employee made contributions of $600 and had 
received no payments, the remaining amount of $2,400 will be considered 
a gain from the sale or exchange of a capital asset held for more than 
six months.
    (b)(1) The term ``total amounts'' means the balance to the credit of 
an employee with respect to all annuities under the annuity plan which 
becomes payable to the payee by reason of the employee's death or other 
separation from the service, or by reason of his death after separation 
from the service. If an employee commences to receive annuity payments 
on retirement and then a lump sum payment is made to his widow upon his 
death, the capital gains treatment applies to the lump sum payment, but 
it does not apply to amounts received before the time the ``total 
amounts'' become payable. However, if the total amount to the credit of 
the employee at the time of his death or other separation from the 
service or death after separation from the service is paid or includible 
in the gross income of the payee within one taxable year of the payee, 
such amount is entitled to the capital gains treatment notwithstanding 
that in a later taxable year an additional amount is credited to the 
employee and paid to the payee.
    (2) If more than one annuity contract is received under the plan, 
the capital gains treatment does not apply to any amount received on the 
surrender thereof unless all contracts under the plan with respect to a 
particular employee are surrendered either at the time of the employee's 
death or other separation from the service or death after separation 
from the service. Thus, if an employee receives two contracts on 
separation from the service and surrenders one of them in the year of 
separation and receives payments

[[Page 410]]

under the other until his death, the capital gains treatment is 
applicable to the balance paid to his beneficiary on his death if paid 
within one taxable year of the beneficiary. The amount received by the 
employee on surrender of the contract in the year of his separation from 
the service, however, would not receive capital gains treatment since 
the balance to the credit of the employee with respect to all amounts 
under the plan did not become payable at that time.
    (3) If an employee retires and commences to receive an annuity but 
subsequently in some succeeding taxable year, he is paid a lump sum in 
settlement of all future annuity payments, the capital gains treatment 
does not apply to such lump sum settlement paid during the lifetime of 
the employee since it is not a payment on account of separation from the 
service, or death after separation, but is on account of the settlement 
of future annuity payments.
    (4) If the ``total amounts'' payable under all annuity contracts 
under the plan with respect to a particular employee are paid or 
includible in the gross income of several payees within one taxable year 
on account of the employee's death or other separation from the service 
or on account of his death after separation from the service, the 
capital gains treatment is applicable. Thus, if the balance to the 
credit of a deceased employee under all annuity contracts provided under 
an annuity plan becomes payable to two payees, the capital gains 
treatment is applicable provided the ``total amounts'' payable are 
received by or includible in the gross income of both payees within the 
same taxable year. However, if the ``total amounts'' payable are made 
available to each payee and one elects to receive his share in cash 
while the other makes a timely election under section 72(h) to receive 
his share as an annuity, the capital gains treatment does not apply to 
either payee.
    (5) For purposes of determining whether the total amounts payable to 
an employee have been paid within one taxable year, the term ``total 
amounts'' includes amounts under a plan which are attributable to 
contributions on behalf of an individual while he was self-employed in 
the business with respect to which the plan was established. Thus, the 
``total amounts'' payable are not paid within one taxable year if 
amounts remain payable which are so attributable.
    (6) The term ``total amounts'' does not include any amount which has 
been placed in a separate account for the funding of benefits described 
in section 401(h). Thus, a distribution under a qualified annuity plan 
may constitute a distribution of the total amounts payable with respect 
to an employee even though amounts attributable to the funding of 
section 401(h) medical benefits as defined in paragraph (a) of Sec. 
1.401-14 are not so distributed.
    (c) The provisions of this section are not applicable to any amounts 
paid to a payee to the extent such amounts are attributable to 
contributions made on behalf of an employee while he was a self-employed 
individual in the business with respect to which the plan was 
established. For the taxation of such amounts, see Sec. 1.72-18. For 
the rules for determining the amount attributable to contributions on 
behalf of an employee while he was self-employed, see paragraphs (b)(4) 
and (c)(2) of such section.

[T.D. 6500, 25 FR 11681, Nov. 26, 1960, as amended by T.D. 6676, 28 FR 
10143, Sept. 17, 1963; T.D. 6722, 29 FR 5073, Apr. 14, 1964]