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May 10, 1995
Refer Reply to: CP:E:EP:A:2
In re: * * *
Dear * * *
This letter is in response to your request, dated November 29, 1993, for a ruling on behalf of Taxpayer M as to whether certain proposed distributions from two individual retirement accounts (IRAs) owned by Taxpayer M are part of a series of substantially equal periodic payments and are therefore not subject to the 10% additional tax imposed under section 72(t) of the Internal Revenue Code (Code) on early distributions. The original request was modified by a letter faxed to our office on May 9, 1994, and in telephone calls with our office in the following ways: the methodology and assumptions used to calculate the annuity factor were changed; the year in which the stream of payments will commence was changed to 1995; and the account balance to be used for calculating payments was modified.
According to the facts, Taxpayer M, born on March 16, 1940, is the owner of two IRAs, IRA 1 and IRA 2. Assets held in one of the two IRAs are, periodically, transferred to the other of the two IRAs. Taxpayer M would like to start receiving annual payments from these two IRAs in 1995. The two IRAs will be aggregated for purposes of calculating an annual distribution amount, and the distribution amount will be taken out of IRA 1 or IRA 2 or both IRA 1 and IRA 2. The annual distribution amount for 1995 will be calculated by dividing the total aggregated account balance as of December 31, 1994, of IRAs 1 and 2 by an annuity factor. The annuity factor will be calculated using commutation functions based on the UP1984 Mortality Table, Taxpayer M’s age attained in 1995, and an interest assumption equal to the annually compounded MidTerm Applicable Federal Rate used for purposes of section 1274(d) of the Code in effect on January 1, 1995. Annual distribution amounts for subsequent years will be calculated in a similar manner by dividing the aggregated account balance of IRA 1 and IRA 2 as of December 31 of the prior year by an annuity factor, calculated using commutation functions based on the UP1984 Mortality Table, the age attained in the distribution year, and an interest assumption equal to the annually compounded MidTerm Applicable Federal Rate in effect on January 1 of the distribution year.
Section 408(d) of the Internal Revenue Code provides that amounts paid or distributed out of an individual retirement plan must be included in gross income by the payee or distributee in the manner provided under section 72 of the Code.
Section 72 of the Internal Revenue Code provides rules for determining how amounts received as annuities, endowments, or life insurance contracts and distributions from qualified plans are to be taxed.
Section 72(t) of the Internal Revenue Code was added to the Code by the Tax Reform Act of 1986 (TRA ’86), effective generally for taxable years beginning after December 31, 1986. Section 72(t)(1) provides for the imposition of an additional 10% tax on early distributions from qualified plans, including IRAs. The additional tax is imposed on that portion of the distribution which is includible in gross income.
Section 72(t)(2)(A)(iv) of the Code provides that section 72(t)(1) shall not apply to distributions which are part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his beneficiary.
Section 72(t)(4) of the Code imposes the additional limitation on distributions excepted from the 10% tax by section 72(t)(2)(A)(iv) that if the series of payments is subsequently modified (other than by reason of death or disability) before the later of (1) the close of the 5year period beginning with the date of the first payment, and (2) the employee’s attainment of age 591/2, then the taxpayer’s tax for the first taxable year in which such modification occurs shall be increased by an amount determined under regulations, equal to the tax which would have been imposed except for the section 72(t)(2)(A)(iv) exception, plus interest for the deferral period.
Notice 8925 was published on March 20, 1989, and provided guidance, in the form of questions and answers, on certain provisions of the Tax Reform Act of 1986 (TRA ’86). In the absence of regulations on section 72(t) of the Code, this notice provided guidance with respect to the exception to the tax on premature distributions provided under section 72(t)(2)(A)(iv). Q&A12 of Notice 8925 provides three methods for determining substantially equal periodic payments for purposes of section 72(t)(2)(A)(iv) of the Code. Two of these methods involve the use of an interest rate assumption which must be an interest rate that does not exceed a reasonable interest rate on the date payments commence.
The method proposed by Taxpayer M in the ruling request, as modified, for determining annual periodic payments is to calculate an annual distribution amount for 1995 by dividing the sum of the account balances of IRA l and IRA 2 as of December 31, 1994, by an annuity factor which is the present value of a one dollar per year life annuity commencing at age 55. The annuity factor is calculated using Taxpayer M’s age attained in 1995 and commutation functions derived from the UP1984 Mortality Table where the assumed interest rate of earnings is equal to the annually compounded MidTerm Applicable Federal Rate (used for purposes of Code section 1274(d)) in effect on January 1, 1995, rounded to the nearest whole or half percent. Thus, the annuity factor used in calculating the 1995 distribution amount is calculated using a commencement age of 55 and commutation functions based on the UP1984 Mortality Table where an interest rate of earnings equal to 8 percent (7.92 percent, rounded to 8.0 percent) is assumed. The annual distribution amount will be paid from IRA 1 or IRA 2 or from both IRA 1 and IRA 2.
Under the proposed method, as modified, the annual distribution amount will be recalculated each year by dividing the total aggregated account balance of IRAs 1 and 2 as of December 31 of the prior year by an annuity factor which is the present value of a one dollar per year life annuity commencing at the age attained in the distribution year. The annuity factor will be calculated using the age attained by Taxpayer M in the distribution year and commutation functions derived from the UP1984 Mortality Table where the assumed interest rate of earnings is equal to the annually compounded Mid Term Applicable Federal Rate (used for purposes of Code section 1274(d)) in effect on January 1 of the distribution year, rounded to the nearest whole or half percent.
The mortality table and the interest rate used are such that they do not result in the circumvention of the requirements of sections 72(t)(2)(A)(iv) and 72(t)(4) of the Code (through the use of an unreasonably high interest rate or an unreasonable mortality table).
We conclude that the proposed method (as modified) of determining periodic payments satisfies one of the methods described in Notice 8925 and results in substantially equal periodic payments within the meaning of section 72(t)(2)(A)(iv) of the Code, and such payments will not be subject to the additional tax of section 72(t) unless the requirements of section 72(t)(4) are not met.
Sincerely yours,
Kathryn Marticello
Chief, Actuarial Branch 2


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