As part of AdvisorOne’s Special Report, 22 Days of Tax Planning Advice for 2012, throughout the month of March 2012, we are partnering with our Summit Business Media sister service, Tax Facts Online, to take a deeper dive into certain tax planning issues in a convenient Q&A format. In this, the fourth article, we first define and then look at the tax treatment of lump sum distributions.
What is a lump sum distribution? What special tax treatment is available for a lump sum distribution from a qualified plan?
A distribution is a lump sum distribution if it:
(1) is made in one taxable year;
(2) consists of the balance to the credit of an employee;
(3) is payable on account of the employee’s death, after the employee attained age 59 1/2, or on account of the employee’s separation from service; and
(4) is made from a qualified pension, profit sharing, or stock bonus plan.
The classification will be relevant to certain distributions of employer securities that consist of net unrealized appreciations.
The distinction between lump sum distributions has become less important as fewer participants are able to use the pre-ERISA grandfather provisions for capital gain treatment of pre-ERISA accounts under a plan and certain income averaging rules that were repealed in 1986. The following discussion applies to the grandfathered tax treatment of certain participant accounts that are conditioned on a distribution constituting a lump sum distribution.
The same requirements apply to distributions to self-employed individuals, except that full distributions made after a self-employed person has become disabled are considered lump sum distributions, and distributions made on account of “separation from service” are not.
The balance to the credit includes all amounts in the participant’s account, including nondeductible employee contributions, as of the first distribution received after the triggering event.