This section of the publication explains how any nonperiodic distributions you receive under a pension or annuity plan are taxed. Nonperiodic distributions are also known as amounts not received as an annuity. They include all payments other than periodic payments and corrective distributions.
For example, the following items are treated as nonperiodic distributions.
- Cash withdrawals.
- Distributions of current earnings (dividends) on your investment. However, do not include these distributions in your income to the extent the insurer keeps them to pay premiums or other consideration for the contract.
- Certain loans. See Loans Treated as Distributions, later.
- The value of annuity contracts transferred without full and adequate consideration. See Transfers of Annuity Contracts, later.
Generally, if the contributions made for you during the year to certain retirement plans exceed certain limits, the excess is taxable to you. To correct an excess, your plan may distribute it to you (along with any income earned on the excess). Although the plan reports the corrective distributions on Form 1099-R, the distribution is not treated as a nonperiodic distribution from the plan. It is not subject to the allocation rules explained in the following discussion, it cannot be rolled over into another plan, and it is not subject to the additional tax on early distributions.
If your retirement plan made a corrective distribution of excess amounts (excess deferrals, excess contributions, or excess annual additions), your Form 1099-R, should have the code "8," "B," "D," "P," or "E" in box 7.
For information on plan contribution limits and how to report corrective distributions of excess contributions, see Retirement Plan Contributions under Employee Compensation in Publication 525.taxmap/pubs/p575-003.htm#en_us_publink10004446
How you figure the taxable amount of a nonperiodic distribution depends on whether it is made before the annuity starting date or on or after the annuity starting date. If it is made before the annuity starting date, its tax treatment also depends on whether it is made under a qualified or nonqualified plan and, if it is made under a nonqualified plan, whether it fully discharges the contract, is received under certain life insurance or endowment contracts, or is allocable to an investment you made before August 14, 1982.
You may be able to roll over the taxable amount of a nonperiodic distribution from a qualified retirement plan into another qualified retirement plan or a traditional IRA tax free. See Rollovers, later. If you do not make a tax-free rollover and the distribution qualifies as a lump-sum distribution, you may be able to elect an optional method of figuring the tax on the taxable amount. See Lump-Sum Distributions, later.
The annuity starting date is either the first day of the first period for which you receive an annuity payment under the contract or the date on which the obligation under the contract becomes fixed, whichever is later. taxmap/pubs/p575-003.htm#en_us_publink10004449
If you receive a distribution of employer securities from a qualified retirement plan, you may be able to defer the tax on the net unrealized appreciation (NUA) in the securities. The NUA is the net increase in the securities' value while they were in the trust. This tax deferral applies to distributions of the employer corporation's stocks, bonds, registered debentures, and debentures with interest coupons attached.
If the distribution is a lump-sum distribution, tax is deferred on all of the NUA unless you choose to include it in your income for the year of the distribution.
A lump-sum distribution for this purpose is the distribution or payment of a plan participant's entire balance (within a single tax year) from all of the employer's qualified plans of one kind (pension, profit-sharing, or stock bonus plans), but only if paid:
- Because of the plan participant's death,
- After the participant reaches age 591/2,
- Because the participant, if an employee, separates from service, or
- After the participant, if a self-employed individual, becomes totally and permanently disabled.
If you choose to include NUA in your income for the year of the distribution and the participant was born before January 2, 1936, you may be able to figure the tax on the NUA using the optional methods described under Lump-Sum Distributions, later.
If the distribution is not a lump-sum distribution, tax is deferred only on the NUA resulting from employee contributions other than deductible voluntary employee contributions.
The NUA on which tax is deferred should be shown in box 6 of the Form 1099-R you receive from the payer of the distribution.
When you sell or exchange employer securities with tax-deferred NUA, any gain is long-term capital gain up to the amount of the NUA that is not included in your basis in the employer securities. Any gain that is more than the NUA is long-term or short-term gain, depending on how long you held the securities after the distribution.
Your basis in the employer securities is the total of the following amounts.
- Your contributions to the plan that are attributable to the securities.
- Your employer's contributions that were taxed as ordinary income in the year the securities were distributed.
- Your NUA in the securities that is attributable to employer contributions and taxed as ordinary income in the year the securities were distributed.
Enter the total amount of a nonperiodic distribution on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. Enter the taxable amount of the distribution on Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. However, if you make a tax-free rollover or elect an optional method of figuring the tax on a lump-sum distribution, see How to report in the discussions of those tax treatments, later.taxmap/pubs/p575-003.htm#en_us_publink10004452
If you receive a nonperiodic payment from your annuity contract on or after the annuity starting date, you generally must include all of the payment in gross income. For example, a cost-of-living increase in your pension after the annuity starting date is an amount not received as an annuity and, as such, is fully taxable. taxmap/pubs/p575-003.htm#en_us_publink10004453
If the annuity payments you receive are reduced because you received a nonperiodic distribution, you can exclude part of the nonperiodic distribution from gross income. The part you can exclude is equal to your cost in the contract reduced by any tax-free amounts you previously received under the contract, multiplied by a fraction. The numerator is the reduction in each annuity payment because of the nonperiodic distribution. The denominator is the full unreduced amount of each annuity payment originally provided for. taxmap/pubs/p575-003.htm#en_us_publink10004454
If you receive a single-sum payment on or after your annuity starting date in connection with the start of annuity payments for which you must use the Simplified Method, treat the single-sum payment as if it were received before your annuity starting date. (See Simplified Method under Taxation of Periodic Payments, earlier, for information on its required use.) Follow the rules in the next discussion, Distribution Before Annuity Starting Date From a Qualified Plan. taxmap/pubs/p575-003.htm#en_us_publink10004455
You may receive an amount on or after the annuity starting date that fully satisfies the payer's obligation under the contract. The amount may be a refund of what you paid for the contract or for the complete surrender, redemption, or maturity of the contract. Include the amount in gross income only to the extent that it exceeds the remaining cost of the contract. taxmap/pubs/p575-003.htm#en_us_publink10004456
If you receive a nonperiodic distribution before the annuity starting date from a qualified retirement plan, you generally can allocate only part of it to the cost of the contract. You exclude from your gross income the part that you allocate to the cost. You include the remainder in your gross income.
For this purpose, a qualified retirement plan is:
- A qualified employee plan (or annuity contract purchased by such a plan),
- A qualified employee annuity plan, or
- A tax-sheltered annuity plan (403(b) plan).
Use the following formula to figure the tax-free amount of the distribution.
| || || || || || |
| ||Amount received||x||Cost of contract||=||Tax-free amount|
| ||Account balance|
For this purpose, your account balance includes only amounts to which you have a nonforfeitable right (a right that cannot be taken away). taxmap/pubs/p575-003.htm#en_us_publink10004457
Ann Brown received a $50,000 distribution from her retirement plan before her annuity starting date. She had $10,000 invested (cost) in the plan. Her account balance was $100,000. She can exclude $5,000 of the $50,000 distribution, figured as follows:
| || || || || || |
Under a defined contribution plan, your contributions (and income allocable to them) may be treated as a separate contract for figuring the taxable part of any distribution. A defined contribution plan is a plan in which you have an individual account. Your benefits are based only on the amount contributed to the account and the income, expenses, etc., allocated to the account.taxmap/pubs/p575-003.htm#en_us_publink10004459
Ryan participates in a defined contribution plan that treats employee contributions and earnings allocable to them as a separate contract. He received a non-annuity distribution of $5,000 before his annuity starting date. He had made after-tax contributions of $10,000. The earnings allocable to his contributions were $2,500. His employer also contributed $10,000. The earnings allocable to the employer contributions were $2,500.
To determine the tax-free amount of Ryan's distribution use the same formula shown above. However, because employee contributions are treated as a separate contract the account balance would be the total of Ryan's contributions and allocable earnings.
Thus the tax-free amount would be $5,000 × ($10,000 ÷ $12,500) = $4,000. The taxable amount would be $1,000 ($5,000 − $4,000).
If the employee contributions were not treated as a separate contract, the tax-free amount would be $2,000 ($5,000 × ($10,000 ÷ $25,000)) and the taxable amount would be $3,000 ($5,000 − $2,000).taxmap/pubs/p575-003.htm#en_us_publink10004460
If you contributed before 1987 to a pension plan that, as of May 5, 1986, permitted you to withdraw your contributions before your separation from service, any distribution before your annuity starting date is tax free to the extent that it, when added to earlier distributions received after 1986, does not exceed your cost as of December 31, 1986. Apply the allocation described in the preceding discussion only to any excess distribution. taxmap/pubs/p575-003.htm#en_us_publink10004461
If you receive a nonperiodic distribution before the annuity starting date from a plan other than a qualified retirement plan, it is allocated first to earnings (the taxable part) and then to the cost of the contract (the tax-free part). This allocation rule applies, for example, to a commercial annuity contract you bought directly from the issuer. You include in your gross income the smaller of:
- The nonperiodic distribution, or
- The amount by which the cash value of the contract (figured without considering any surrender charge) immediately before you receive the distribution exceeds your investment in the contract at that time.
You bought an annuity from an insurance company. Before the annuity starting date under your annuity contract, you received a $7,000 distribution. At the time of the distribution, the annuity had a cash value of $16,000 and your investment in the contract was $10,000. The distribution is allocated first to earnings, so you must include $6,000 ($16,000 − $10,000) in your gross income. The remaining $1,000 ($7,000 − $6,000) is a tax-free return of part of your investment.taxmap/pubs/p575-003.htm#en_us_publink10004463
Certain nonperiodic distributions received before the annuity starting date are not subject to the allocation rule in the preceding discussion. Instead, you include the amount of the payment in gross income only to the extent that it exceeds the cost of the contract.
This exception applies to the following distributions.
- Distributions in full discharge of a contract that you receive as a refund of what you paid for the contract or for the complete surrender, redemption, or maturity of the contract.
- Distributions from life insurance or endowment contracts (other than modified endowment contracts, as defined in section 7702A of the Internal Revenue Code) that are not received as an annuity under the contracts.
- Distributions under contracts entered into before August 14, 1982, to the extent that they are allocable to your investment before August 14, 1982.
If you bought an annuity contract before August 14, 1982, and made investments both before August 14, 1982, and later, the distributed amounts are allocated to your investment or to earnings in the following order.
- The part of your investment that was made before August 14, 1982. This part of the distribution is tax free.
- The earnings on the part of your investment that was made before August 14, 1982. This part of the distribution is taxable.
- The earnings on the part of your investment that was made after August 13, 1982. This part of the distribution is taxable.
- The part of your investment that was made after August 13, 1982. This part of the distribution is tax free.
If you receive U.S. savings bonds in a taxable distribution from a retirement or profit-sharing plan, report the value of the bonds at the time of distribution as income. The value of the bonds includes accrued interest. When you cash the bonds, your Form 1099-INT will show the total interest accrued, including the part you reported when the bonds were distributed to you. For information on how to adjust your interest income for U.S. savings bond interest you previously reported, see How To Report Interest Income in chapter 1 of Publication 550, Investment Income and Expenses. taxmap/pubs/p575-003.htm#en_us_publink10004465
If you borrow money from your retirement plan, you must treat the loan as a nonperiodic distribution from the plan unless it qualifies for the exception to this loan-as-distribution rule explained later. This treatment also applies to any loan under a contract purchased under your retirement plan, and to the value of any part of your interest in the plan or contract that you pledge or assign (or agree to pledge or assign). It applies to loans from both qualified and nonqualified plans, including commercial annuity contracts you purchase directly from the issuer. Further, it applies if you renegotiate, extend, renew, or revise a loan that qualified for the exception below if the altered loan does not qualify. In that situation, you must treat the outstanding balance of the loan as a distribution on the date of the transaction.
You determine how much of the loan is taxable using the allocation rules for nonperiodic distributions discussed under Figuring the Taxable Amount, earlier. The taxable part may be subject to the additional tax on early distributions. It is not an eligible rollover distribution and does not qualify for the 10-year tax option. taxmap/pubs/p575-003.htm#en_us_publink10004466
At least part of certain loans under a qualified employee plan, qualified employee annuity, tax-sheltered annuity (403(b) plan), or government plan is not treated as a distribution from the plan. This exception to the loan-as-distribution rule applies only to a loan that either:
- Is used to acquire your main home, or
- Must be repaid within 5 years.
If a loan qualifies for this exception, you must treat it as a nonperiodic distribution only to the extent that the loan, when added to the outstanding balances of all your loans from all plans of your employer (and certain related employers) exceeds the lesser of:
- $50,000, or
- Half the present value (but not less than $10,000) of your nonforfeitable accrued benefit under the plan, determined without regard to any accumulated deductible employee contributions.
You must reduce the $50,000 amount if you already had an outstanding loan from the plan during the 1-year period ending the day before you took out the loan. The amount of the reduction is your highest outstanding loan balance during that period minus the outstanding balance on the date you took out the new loan. If this amount is zero or less, ignore it. taxmap/pubs/p575-003.htm#en_us_publink10004467
To qualify for the exception to the loan-as-distribution rule, the loan must require substantially level payments at least quarterly over the life of the loan. If the loan is from a designated Roth account, the payments must be satisfied separately for that part of the loan and for the part of the loan from other accounts under the plan. This level payment requirement does not apply to the period in which you are on a leave of absence without pay or with a rate of pay that is less than the required installment. Generally, this leave of absence must not be longer than 1 year. You must repay the loan within 5 years from the date of the loan (unless the loan was used to acquire your main home). Your installment payments after the leave ends must not be less than your original payments.
However, if your plan suspends your loan payments for any part of the period during which you are in the uniformed services, you will not be treated as having received a distribution even if the suspension is for more than 1 year and the term of the loan is extended. The loan payments must resume upon completion of such period and the loan must be repaid in substantially level installments within 5 years from the date of the loan (unless the loan was used to acquire your main home) plus the period of suspension.taxmap/pubs/p575-003.htm#en_us_publink10004468
On May 1, 2008, you borrowed $40,000 from your retirement plan. The loan was to be repaid in level monthly installments over 5 years. The loan was not used to acquire your main home. You make nine monthly payments and start an unpaid leave of absence that lasts for 12 months. You were not in a uniformed service during this period. After the leave period ends and you resume active employment, you resume making repayments on the loan. You must repay this loan by April 30, 2013 (5 years from the date of this loan). You can increase your monthly installments or you can make the original monthly installments and on April 30, 2013, pay the balance.taxmap/pubs/p575-003.htm#en_us_publink10004469
The facts are the same as in Example 1, except that you are on a leave of absence performing service in the uniformed services for 2 years. The loan payments were suspended for that period. You must resume making loan payments at the end of that period and the loan must be repaid by April 30, 2015 (5 years from the date of the loan plus the period of suspension).taxmap/pubs/p575-003.htm#en_us_publink10004470
In determining loan balances for purposes of applying the exception to the loan-as-distribution rule, you must add the balances of all your loans from all plans of your employer and from all plans of your employers who are treated as a single employer. Treat separate employers' plans as plans of a single employer if they are treated that way under other qualified retirement plan rules because the employers are related.
Employers are related if they are:
- Members of a controlled group of corporations,
- Businesses under common control, or
- Members of an affiliated service group.
An affiliated service group generally is two or more service organizations whose relationship involves an ownership connection. Their relationship also includes the regular or significant performance of services by one organization for or in association with another. taxmap/pubs/p575-003.htm#en_us_publink10004471
If the loan from a qualified plan is not treated as a distribution because the exception applies, you cannot deduct any of the interest on the loan during any period that:
- The loan is secured by amounts from elective deferrals under a qualified cash or deferred arrangement (section 401(k) plan) or a salary reduction agreement to purchase a tax-sheltered annuity, or
- You are a key employee as defined in section 416(i) of the Internal Revenue Code.
If your loan is treated as a distribution, you should receive a Form 1099-R showing code "L" in box 7. taxmap/pubs/p575-003.htm#en_us_publink10004473
If your loan is treated as a distribution, you must reduce your investment in the contract to the extent that the distribution is tax free under the allocation rules for qualified plans explained earlier. Repayments of the loan increase your investment in the contract to the extent that the distribution is taxable under those rules.
If you receive a loan under a nonqualified plan other than a 403(b) plan, including a commercial annuity contract that you purchase directly from the issuer, you increase your investment in the contract to the extent that the distribution is taxable under the general allocation rule for nonqualified plans explained earlier. Repayments of the loan do not affect your investment in the contract. However, if the distribution is excepted from the general allocation rule (for example, because it is made under a contract entered into before August 14, 1982), you reduce your investment in the contract to the extent that the distribution is tax free and increase it for loan repayments to the extent that the distribution is taxable. taxmap/pubs/p575-003.htm#en_us_publink10004474
If you transfer without full and adequate consideration an annuity contract issued after April 22, 1987, you are treated as receiving a nonperiodic distribution. The distribution equals the excess of:
- The cash surrender value of the contract at the time of transfer, over
- Your investment in the contract at that time.
This rule does not apply to transfers between spouses or transfers between former spouses incident to a divorce.
No gain or loss is recognized on an exchange of an annuity contract for another annuity contract if the insured or annuitant remains the same. However, if an annuity contract is exchanged for a life insurance or endowment contract, any gain due to interest accumulated on the contract is ordinary income.
If you transfer a full or partial interest in a tax-sheltered annuity that is not subject to restrictions on early distributions to another tax-sheltered annuity, the transfer qualifies for nonrecognition of gain or loss.
If you exchange an annuity contract issued by a life insurance company that is subject to a rehabilitation, conservatorship, or similar state proceeding for an annuity contract issued by another life insurance company, the exchange qualifies for nonrecognition of gain or loss. The exchange is tax free even if the new contract is funded by two or more payments from the old annuity contract. This also applies to an exchange of a life insurance contract for a life insurance, endowment, or annuity contract.
If you transfer part of the cash surrender value of an existing annuity contract for a new annuity contract issued by another insurance company, the transfer qualifies for nonrecognition of gain or loss. The funds must be transferred directly between the insurance companies. Your investment in the original contract immediately before the exchange is allocated between the contracts based on the percentage of the cash surrender value allocated to each contract.taxmap/pubs/p575-003.htm#en_us_publink10004476
You own an annuity contract issued by ABC Insurance. You assign 60% of the cash surrender value of that contract to DEF Insurance to purchase an annuity contract. The funds are transferred directly between the insurance companies. You do not recognize any gain or loss on the transaction. After the exchange, your investment in the new contract is equal to 60% of your investment in the old contract immediately before the exchange. Your investment in the old contract is equal to 40% of your original investment in that contract.taxmap/pubs/p575-003.htm#en_us_publink10004477
If you receive cash from the surrender of one contract and invest the cash in another contract, you generally do not have a tax-free transfer. However, you can elect to receive tax-free treatment for a cash distribution from an insurance company that is subject to a rehabilitation, conservatorship, insolvency, or similar state proceeding if all of the following conditions are met.
- You withdraw all the cash to which you are entitled.
- You reinvest the proceeds within 60 days in a single contract issued by another insurance company.
- You assign all rights to any future distributions to the new issuer if the cash distribution is restricted by the state proceeding to an amount that is less than required for full settlement.
- An exchange of these contracts would otherwise qualify as a tax-free transfer.
You must give the new issuer a statement containing the following information.
- The amount of cash distributed under the old contract.
- The amount of cash reinvested in the new contract.
- Your investment in the old contract on the date of the initial distribution.
You must also attach the following items to your timely filed income tax return for the year of the initial distribution.
- A copy of the statement you gave to the new issuer.
- A statement that contains the words "ELECTION UNDER REV. PROC. 92-44," the new issuer's name, and the policy number or similar identifying information for the new contract.
If you make a tax-free exchange of an annuity contract for another annuity contract issued by a different company, the exchange will be shown on Form 1099-R with a code "6" in box 7. You need not report this on your tax return.taxmap/pubs/p575-003.htm#en_us_publink10004479
If you acquire an annuity contract in a tax-free exchange for another annuity contract, its date of purchase is the date you purchased the annuity you exchanged. This rule applies for determining if the annuity qualifies for exemption from the tax on early distributions as an immediate annuity. See Tax on Early Distributions, later.taxmap/pubs/p575-003.htm#en_us_publink10004480
This section on lump-sum distributions only applies if the plan participant was born before January 2, 1936. If the plan participant was born after January 1, 1936, the taxable amount of this nonperiodic payment is reported as discussed earlier.
A lump-sum distribution is the distribution or payment in one tax year of a plan participant's entire balance from all of the employer's qualified plans of one kind (for example, pension, profit-sharing, or stock bonus plans). A distribution from a nonqualified plan (such as a privately purchased commercial annuity or a section 457 deferred compensation plan of a state or local government or tax-exempt organization) cannot qualify as a lump-sum distribution.
The participant's entire balance from a plan does not include certain forfeited amounts. It also does not include any deductible voluntary employee contributions allowed by the plan after 1981 and before 1987.
If you receive a lump-sum distribution from a qualified employee plan or qualified employee annuity and the plan participant was born before January 2, 1936, you may be able to elect optional methods of figuring the tax on the distribution. The part from active participation in the plan before 1974 may qualify as capital gain subject to a 20% tax rate. The part from participation after 1973 (and any part from participation before 1974 that you do not report as capital gain) is ordinary income. You may be able to use the 10-year tax option, discussed later, to figure tax on the ordinary income part.
Each individual, estate, or trust who receives part of a lump-sum distribution on behalf of a plan participant who was born before January 2, 1936, can choose whether to elect the optional methods for the part each received. However, if two or more trusts receive the distribution, the plan participant or the personal representative of a deceased participant must make the choice.
Use Form 4972 to figure the separate tax on a lump-sum distribution using the optional methods. The tax figured on Form 4972 is added to the regular tax figured on your other income. This may result in a smaller tax than you would pay by including the taxable amount of the distribution as ordinary income in figuring your regular tax. taxmap/pubs/p575-003.htm#en_us_publink10004482
If you receive a distribution as an alternate payee under a qualified domestic relations order (discussed earlier under General Information), you may be able to choose the optional tax computations for it. You can make this choice for a distribution that would be treated as a lump-sum distribution had it been received by your spouse or former spouse (the plan participant). However, for this purpose, the balance to your credit does not include any amount payable to the plan participant.
If you choose an optional tax computation for a distribution received as an alternate payee, this choice will not affect any election for distributions from your own plan. taxmap/pubs/p575-003.htm#en_us_publink10004483
One or all of the recipients of a lump-sum distribution can use the optional tax computations. See Multiple recipients of a lump-sum distribution in the instructions for Form 4972. taxmap/pubs/p575-003.htm#en_us_publink10004484
A separated employee's vested percentage in his or her retirement benefit may increase if he or she is rehired by the employer within five years following separation from service. This possibility does not prevent a distribution made before reemployment from qualifying as a lump-sum distribution. However, if the employee elected an optional method of figuring the tax on the distribution and his or her vested percentage in the previous retirement benefit increases after reemployment, the employee must recapture the tax saved. This is done by increasing the tax for the year in which the increase in vesting first occurs. taxmap/pubs/p575-003.htm#en_us_publink10004485
The following distributions do not qualify as lump-sum distributions for the capital gain treatment or 10-year tax option.
- The part of a distribution not rolled over if the distribution is partially rolled over to another qualified plan or an IRA.
- Any distribution if an earlier election to use either the 5- or 10-year tax option had been made after 1986 for the same plan participant.
- U.S. Retirement Plan Bonds distributed with a lump sum.
- Any distribution made during the first five tax years that the participant was in the plan, unless it was made because the participant died.
- The current actuarial value of any annuity contract included in the lump sum. (Form 1099-R, box 8, should show this amount, which you use only to figure tax on the ordinary income part of the distribution.)
- Any distribution to a 5% owner that is subject to penalties under section 72(m)(5)(A) of the Internal Revenue Code.
- A distribution from an IRA.
- A distribution from a tax-sheltered annuity (section 403(b) plan).
- A distribution of the redemption proceeds of bonds rolled over tax free to a qualified pension plan, etc., from a qualified bond purchase plan.
- A distribution from a qualified plan if the participant or his or her surviving spouse previously received an eligible rollover distribution from the same plan (or another plan of the employer that must be combined with that plan for the lump-sum distribution rules) and the previous distribution was rolled over tax free to another qualified plan or an IRA.
- A distribution from a qualified plan that received a rollover after 2001 from an IRA (other than a conduit IRA), a governmental section 457 plan, or a section 403(b) tax-sheltered annuity on behalf of the plan participant.
- A distribution from a qualified plan that received a rollover after 2001 from another qualified plan on behalf of that plan participant's surviving spouse.
- A corrective distribution of excess deferrals, excess contributions, excess aggregate contributions, or excess annual additions.
- A lump-sum credit or payment from the Federal Civil Service Retirement System (or the Federal Employees' Retirement System).
If you receive a lump-sum distribution, you may have the following options for how to treat the taxable part.
- Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and the part from participation after 1973 as ordinary income.
- Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and use the 10-year tax option to figure the tax on the part from participation after 1973 (if you qualify).
- Use the 10-year tax option to figure the tax on the total taxable amount (if you qualify).
- Roll over all or part of the distribution. See Rollovers, later. No tax is currently due on the part rolled over. Report any part not rolled over as ordinary income.
- Report the entire taxable part of the distribution as ordinary income on your tax return.
The first three options are explained in the following discussions.taxmap/pubs/p575-003.htm#en_us_publink10004487
You can choose to use the 10-year tax option or capital gain treatment only once after 1986 for any plan participant. If you make this choice, you cannot use either of these optional treatments for any future distributions for the participant.
Complete Form 4972 and attach it to your Form 1040 if you choose to use one or both of the tax options. If you received more than one lump-sum distribution for a plan participant during the year, you must add them together in your computation. If you and your spouse are filing a joint return and you both have received a lump-sum distribution, each of you should complete a separate Form 4972. taxmap/pubs/p575-003.htm#en_us_publink10004488
You must decide to use the tax options before the end of the time, including extensions, for making a claim for credit or refund of tax. This is usually 3 years after the date the return was filed or 2 years after the date the tax was paid, whichever is later. (Returns filed before their due date are considered filed on their due date.) taxmap/pubs/p575-003.htm#en_us_publink10004489
You can change your mind and decide not to use the tax options within the time period just discussed. If you change your mind, file Form 1040X, Amended U.S. Individual Income Tax Return, with a statement saying you do not want to use the optional lump-sum treatment. Generally, you must pay any additional tax due to the change with the Form 1040X. taxmap/pubs/p575-003.htm#en_us_publink10004490
If you elect capital gain treatment (but not the 10-year tax option) for a lump-sum distribution, include the ordinary income part of the distribution on Form 1040, lines 16a and 16b; or on Form 1040NR, lines 17a and 17b. Enter the capital gain part of the distribution in Part II of Form 4972. Include the tax from Form 4972, line 7 in the total on Form 1040, line 44; or on Form 1040NR, line 41.
If you elect the 10-year tax option, do not include any part of the distribution on Form 1040, lines 16a or 16b; or on Form 1040NR, lines 17a or 17b. Report the entire distribution in Part III of Form 4972 or, if you also elect capital gain treatment, report the capital gain part in Part II and the ordinary income part in Part III. Include the tax from Form 4972, line 30 in the total on Form 1040, line 44; or on Form 1040NR, line 41.taxmap/pubs/p575-003.htm#en_us_publink10004491
The taxable part of a lump-sum distribution is the employer's contributions and income earned on your account. You may recover your cost in the lump sum and any net unrealized appreciation (NUA) in employer securities tax free. taxmap/pubs/p575-003.htm#en_us_publink10004492
In general, your cost is the total of:
- The plan participant's nondeductible contributions to the plan,
- The plan participant's taxable costs of any life insurance contract distributed,
- Any employer contributions that were taxable to the plan participant, and
- Repayments of any loans that were taxable to the plan participant.
You must reduce this cost by amounts previously distributed tax free.
The NUA in employer securities (box 6 of Form 1099-R) received as part of a lump-sum distribution is generally tax free until you sell or exchange the securities. (See Distributions of employer securities under Figuring the Taxable Amount, earlier.) However, if you choose to include the NUA in your income for the year of the distribution and there is an amount in box 3 of Form 1099-R, part of the NUA will qualify for capital gain treatment. Use the NUA Worksheet in the instructions for Form 4972 to find the part that qualifies. taxmap/pubs/p575-003.htm#en_us_publink10004494
You may be able to claim a loss on your return if you receive a lump-sum distribution that is less than the plan participant's cost. You must receive the distribution entirely in cash or worthless securities. The amount you can claim is the difference between the participant's cost and the amount of the cash distribution, if any.
To claim the loss, you must itemize deductions on Schedule A (Form 1040). Show the loss as a miscellaneous deduction subject to the 2%-of-adjusted-gross-income limit.
You cannot claim a loss if you receive securities that are not worthless, even if the total value of the distribution is less than the plan participant's cost. You recognize gain or loss only when you sell or exchange the securities.
A loss under a nonqualified plan, such as a commercial variable annuity, is deductible in the same manner as a lump-sum distribution.
Capital gain treatment applies only to the taxable part of a lump-sum distribution resulting from participation in the plan before 1974. The amount treated as capital gain is taxed at a 20% rate. You can elect this treatment only once for any plan participant, and only if the plan participant was born before January 2, 1936.
Complete Part II of Form 4972 to choose the 20% capital gain election.taxmap/pubs/p575-003.htm#en_us_publink10004497
Generally, figure the capital gain and ordinary income parts of a lump-sum distribution by using the following formulas.
| || || || |
| Capital Gain:|
| ||Total Taxable Amount||×||Months of active participation before 1974|
| ||Total months of active participation|
| ||Total Taxable Amount||×||Months of active participation after 1973|
| ||Total months of active participation|
In figuring the months of active participation before 1974, count as 12 months any part of a calendar year in which the plan participant actively participated under the plan. For active participation after 1973, count as one month any part of a calendar month in which the participant actively participated in the plan.
The capital gain part should be shown in box 3 of Form 1099-R or other statement given to you by the payer of the distribution. taxmap/pubs/p575-003.htm#en_us_publink10004499
If any federal estate tax (discussed under Survivors and Beneficiaries,
later) was paid on the lump-sum distribution, you must decrease the capital gain by the amount of estate tax applicable to it. Follow the Form 4972 instructions for Part II, line 6, to figure the part of the estate tax applicable to the capital gain that is used to reduce the capital gain. If you do not make the capital gain election, enter on line 18 of Part III the estate tax attributable to the total lump-sum distribution. For information on how to figure the estate tax attributable to the lump-sum distribution, get the instructions for Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, or contact the administrator of the decedent's estate. taxmap/pubs/p575-003.htm#en_us_publink10004501
The 10-year tax option is a special formula used to figure a separate tax on the ordinary income part of a lump-sum distribution. You pay the tax only once, for the year in which you receive the distribution, not over the next 10 years. You can elect this treatment only once for any plan participant, and only if the plan participant was born before January 2, 1936.
The ordinary income part of the distribution is the amount shown in box 2a of the Form 1099-R given to you by the payer, minus the amount, if any, shown in box 3. You can also treat the capital gain part of the distribution (box 3 of Form 1099-R) as ordinary income for the 10-year tax option if you do not choose capital gain treatment for that part.
Complete Part III of Form 4972 to choose the 10-year tax option. You must use the special Tax Rate Schedule shown in the instructions for Part III to figure the tax.taxmap/pubs/p575-003.htm#en_us_publink10004502
The following examples show how to figure the separate tax on Form 4972.taxmap/pubs/p575-003.htm#en_us_publink10004503
Robert C. Smith, who was born in 1935, retired from Crabtree Corporation in 2008. He withdrew the entire amount to his credit from the company's qualified pension plan. In December 2008, he received a total distribution of $175,000 (the $25,000 tax-free part of the distribution consisting of employee contributions plus the $150,000 taxable part of the distribution consisting of employer contributions and earnings on all contributions).
The payer gave Robert a Form 1099-R, which shows the capital gain part of the taxable distribution (the part attributable to participation before 1974) to be $10,000. Robert elects 20% capital gain treatment for this part. Filled-in copies of Robert's Form 1099-R and Form 4972 follow. He enters $10,000 on Form 4972, Part II, line 6 and $2,000 ($10,000 × 20%) on Part II, line 7.
The ordinary income part of the taxable distribution is $140,000 ($150,000 minus $10,000). Robert elects to figure the tax on this part using the 10-year tax option. He enters $140,000 on Form 4972, Part III, line 8. Then he completes the rest of Form 4972 and includes the tax of $24,270 in the total on line 44 of his Form 1040. taxmap/pubs/p575-003.htm#en_us_publink10004504
Mary Brown, who was born in 1935, sold her business in 2008. She withdrew her entire interest in the qualified profit-sharing plan she had set up as the sole proprietor.
The cash part of the distribution, $160,000, is all ordinary income and is shown on her Form 1099-R below. She chooses to figure the tax on this amount using the 10-year tax option. Mary also received an annuity contract as part of the distribution from the plan. Box 8, Form 1099-R, shows that the current actuarial value of the annuity was $10,000. She enters these figures on Form 4972 (see page 25).
After completing Form 4972, she includes the tax of $28,070 in the total on Form 1040, line 44.