1977, June, Pg. 973. Tax Tips.

6 Colo.Law. 973

Colorado Lawyer

1977.

1977, June, Pg. 973.

Tax Tips

973Vol. 6, No. 6, Pg. 973Tax TipsPlanning for Distributions from Qualified Retirement Plans

ERISA and the TRA '76 have made some dramatic changes in the taxation of distributions from qualified retirement plans. Proper income and estate tax planning may substantially reduce the tax on these distributions by taking advantage of several alternatives now available.

Income Tax PlanningThe Internal Revenue Code provides for preferential tax treatment for a "lump sum distribution" from a qualified retirement plan, both corporate and Keogh plans. After ERISA, IRC § 402 provides that if a distribution meets the lump sum distribution requirements, for taxable years after December 31, 1973, that portion of the distribution attributable to pre-1974 participation is subject to capital gain treatment. The balance of the distribution constituting the ordinary income portion is, at the taxpayer's election, subject to a special ten-year forward averaging provision. In general, this tax is computed at single taxpayer rates on one-tenth of the total distribution (less a minimum distribution allowance) and the tax multiplied by ten. This result is then multiplied by the employee's percentage of participation after 1973. The tax on the taxpayer's income from other sources plus the capital gain portion of the distribution is then computed in the regular manner including use of the alternative capital gain tax and income averaging, whichever produces the least tax. The tax on this amount is then added to the tax on the ordinary income portion to determine the final tax for the year.

The TRA '76 expanded this provision by permitting the taxpayer to treat the entire lump sum distribution, including that attributable to pre-1974 participation, as ordinary income subject to the ten-year forward averaging provision.(fn1) The economics of this election must always be tested, for in many cases it will reduce the tax. Furthermore, the use of the ten-year averaging provision will eliminate the impact of the increased minimum tax on tax preference items, one item of which is one-half of the taxpayer's long term capital gain.(fn2) The TRA '76 also amended the maximum tax provisions in IRC § 1348 to include amounts received as a pension or annuity which, under certain circumstances, may provide additional relief on distributions from qualified plans.(fn3)

The key to this favorable income tax treatment is meeting the Code requirements of a "lump sum distribution." Such a distribution must be made within

974one taxable year of the recipient, must be...