Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 68-32

1968-1 C.B. 171

Sec. 402

IRS Headnote

Use of a `unit' basis for valuing participants' interests in an exempt employees' trust will not result n a treatment more favorable than use of some other method under section 402(a)(2) of the Internal Revenue Code of 1954, with respect to the amount of excludable net unrealized appreciation on employer securities purchased with employer contributions and dividends on these securities.

Full Text

Rev. Rul. 68-32

Advice has been requested whether the use of a `unit' basis for valuing participants' interests in an exempt employees' trust will result in a treatment more favorable than use of some other method under section 402(a)(2) of the Internal Revenue Code of 1954, with respect to the amount of excludable net unrealized appreciation on employer securities purchased with employer contributions and cash dividends on these securities.

Employee A became a participant under his employer's exempt employees' profit-sharing trust at the inception of the trust. During the period of A's participation the employer contributed a total of $580,000 to the trust, all of which was invested in employer securities. The trust realized aggregate cash dividends of $63,500, which were also invested in employer securities. The average annual payroll of all participating employees was $1,000,000 during this period and A's average annual compensation was $10,000, or one percent of the total. Employees made no contributions under the plan, and employer contributions were allocated to the employees' accounts in proportion to their compensation.

A terminated his employment and received from the trust, within one taxable year, a total distribution of the entire amount payable to him. At the time of the distribution the trust fund was composed of 5,000 shares of employer stock purchased with employer contributions and 500 shares purchased with cash dividends. The total market value of all shares was $715,000, the market value per share thus being $130.

Section 1.402(a)-1(b)(2) of the Income Tax Regulations provides that the amount of net unrealized appreciation in securities of the employer corporation which are distributed by an exempt employees' trust is the excess of the market value of such securities at the time of the distribution over the cost or other basis of such securities to the trust. That section also describes the methods to be used in determining the amount of net unrealized appreciation on employer securities.

The employee is to include in gross income the amount actually distributed or made available to him in accordance with the provisions of section 402(a) of the Code, but, under certain conditions, such amount will not include net unrealized appreciation on employer securities. Where the employee's interest consists of `total distributions payable,' as defined in section 402(a)(3)(C) of the Code, the amount of such distribution is treated as a long term capital gain to the extent that it exceeds the amount contributed by the employee, as determined under section 72(f) of the Code. Thus, the taxable portion of such a distribution consists of employer contributions and income earned on trust investments, but does not include net unrealized appreciation on employer securities in accordance with paragraph (2) of section 402(a) of the Code.

As illustrated below, the use of a `unit' basis in determining an employee's individual interest in trust will not result in more favorable treatment with respect to the amount of the net unrealized appreciation in employer securities.

Assuming that the securities were earmarked to the respective accounts of the participating employees, A will be credit with $5,800, or one percent, of the employer's contributions and $635 of cash dividends. Fifty shares of employer stock purchased with the employer contributions and five additional shares purchased with the cash dividends will be credited to A's account. Thus, the total amount credited to his account will consist of 55 shares of company stock with a value on the date of distribution of $7,150. This results in net unrealized appreciation of $715. Since A received the full amount as a total distribution upon termination of his employment and made no contributions under the plan, he will be taxable at capital gain rates on $6,435, derived from company contributions of $5,800 and cash dividends of $635. The unrealized appreciation of $715 is not currently taxable to him.

If the `unit' basis were used, individual amounts of company stock would not be credited to A's account but he would have a one percent interest in the total trust fund. A's one percent interest would entitle him to a distribution consisting of 55 shares which cost $6,435, and have a value on the date of distribution of $7,150. Hence, A would still be taxable at capital gain rates on $6,435 but would not be currently taxable on the unrealized appreciation of $715.

Thus, the use of either method produces the same result.