[Code of Federal Regulations]
[Title 26, Volume 17]
[Revised as of April 1, 2005]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR54.4981A-1T]

[Page 337-356]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 54_PENSION EXCISE TAXES--Table of Contents
 
Sec. 54.4981A-1T  Tax on excess distributions and excess accumulations 
(temporary).

    The following questions and answers relate to the tax on excess 
distributions and excess accumulations under section 4981A of the 
Internal Revenue Code of 1986, as added by section 1133 of the Tax 
Reform Act of 1986 (Pub. L. 99-514) (TRA '86).

                            Table of Contents

a. General Provisions and Excess Distributions
b. Special Grandfather Rules
c. Special Rules
d. Excess Accumulations

             a. General Provisions and Excess Distributions

    a-1: Q. What changes were made by section 1133 of TRA '86 regarding 
excise taxes applicable to distributions from qualified employer plans 
and individual retirement plans?
    A. Section 1133 of TRA '86 added section 4981A to the Code. Section 
4981A imposes an excise tax of 15 percent on (a) excess distributions, 
as defined in section 4981A(c)(1) and Q&A a-2 of this section, and (b) 
excess accumulations,

[[Page 338]]

as defined in section 4981A(d)(3) and Q&A d-2 of this section. The 
excise tax on excess distributions generally applies to excess 
distributions made after December 31, 1986 (see Q&A c-6 of this 
section). The excise tax on excess accumulations applies to estates of 
decedents dying after December 31, 1986 (see Q&A d-11 of this section). 
Excess distributions are certain distributions from qualified employer 
plans and individual retirement plans. Excess accumulations are certain 
amounts held on the date of death of an employee or individual by 
qualified plans and individual retirement plans.
    a-2: Q. How are excess distributions defined?
    A. Excess distributions are generally defined as the excess of the 
aggregate amount of distributions received by or with respect to an 
individual during a calendar year over the greater of (a) $150,000 
(unindexed) or (b) $112,500 (indexed as provided in Q&A a-9 of this 
section beginning in 1988 for cost-of-living increases). Certain 
individuals may elect to have the portion of their excess distributions 
that is subject to tax determined under a ``special grandfather'' rule 
that is described below (see Q&A b-1 through b-14 of this section).
    a-3: Q. Distributions from what plans and arrangements are taken 
into account in applying section 4981A?
    A. (a) General rule. Section 4981A applies to distributions under 
any qualified employer plan or individual retirement plan described in 
section 4981A(e). For this purpose, a qualified employer plan means 
any--
    (1) Qualified pension, profit-sharing or stock bonus plan described 
in section 401(a) that includes a trust exempt from tax under section 
501(a);
    (2) Annuity plan described in section 403(a);
    (3) Annuity contract, custodial account, or retirement income 
account described in section 403(b)(1), 403(b)(7) or 403(b)(9); and
    (4) Qualified bond purchase plan described in section 405(a) prior 
to that section's repeal by section 491(a) of the Tax Reform Act of 1984 
(TRA '84).
    (b) Individual retirement plan. An individual retirement plan is 
defined in section 7701(a)(37) and means any individual retirement 
account described in section 408(a) or individual retirement annuity 
described in section 408(b). Also, an individual retirement plan 
includes a retirement bond described in section 409(a) prior to that 
section's repeal by section 491(b) of the Tax Reform Act of 1984 (TRA 
'84).
    (c) Other distributions. (1) Distributions under any plan, contract 
or account that has at any time been treated as a qualified employer 
plan or individual retirement plan described in paragraph (a) or (b) of 
this Q&A a-3 will be treated for purposes of section 4981A as 
distributions from a qualified employer plan or individual retirement 
plan whether or not such plan, contract, or account satisfies the 
applicable qualification requirements at the time of the distribution.
    (2)(i) For purposes of this paragraph (c), an employer plan will be 
considered to have been treated as a qualified employer plan if any 
employer maintaining the plan has at any time filed an income tax return 
and claimed deductions that would be allowable under section 404 (and 
that were not disallowed) only if the plan was a qualified employer plan 
under section 401(a) or 403(a). Similarly, if an income tax return has 
been filed at any time with respect to the trust (or plan or insurance 
company), and the income of the trust (insurance company, etc.) is 
reported (and is not disallowed) based on the trust (or plan) being 
treated as a qualified employer plan described in section 401(a), or 403 
(a) or (b), then the employer plan is considered to have been treated as 
a qualified employer plan.
    (ii) For purposes of this paragraph (c), an individual retirement 
plan (IRA) will be considered to have been treated as a qualified IRA if 
any contributions to the IRA were either deducted (or designated as a 
nondeductible contribution described in section 408(o)) on a filed 
individual income tax return or excluded from an individual's gross 
income on a filed income tax return because such contributions were 
reported as regular contributions or rollover contributions (such as 
those described in section 402(a)(5), 403(a)(4), 403(b)(8) or 408(d)(3)) 
to an IRA described in section 408 (a) or (b) (or section 409 of pre-
1984

[[Page 339]]

law). Similar treatment applies to an employer contribution to a 
simplified employee pension described in section 408(k), if such 
contribution is deducted on an employer's filed income tax return, 
including a self-employed individual's return.
    a-4: Q. Which distributions with respect to an individual under a 
qualified employer plan or an individual retirement plan are excluded 
from consideration for purposes of determining an individual's excess 
distributions?
    A. (a) Exclusions. In determining the extent to which an individual 
has excess distributions for a calendar year, the following 
distributions are disregarded--
    (1) Any distribution received by any person with respect to an 
individual as a result of the death of that individual.
    (2) Any distribution with respect to an individual that is received 
by an alternate payee under a qualified domestic relations order within 
the meaning of section 414(p) that is includible in the income of the 
alternate payee.
    (3) Any distribution with respect to an individual that is 
attributable to the individual's investment in the contract as 
determined under the rules of section 72(f). This would include, for 
example, distributions that are excluded from gross income under section 
72 because they are treated as a recovery of after-tax employee 
contributions from a qualified employer plan or nondeductible 
contributions from an individual retirement plan.
    (4) Any portion of a distribution to the extent that it is not 
included in gross income by reason of a rollover contribution described 
in section 402(a)(5), 403(a)(4), 403(b)(8), or 408(d)(3).
    (5) Any health coverage or any distribution of medical benefits 
provided under an arrangement described in section 401(h) to the extent 
that the coverage or distribution is excludible under section 104, 105, 
or 106.
    (b) Alternate payee. Any distributions to an alternate payee 
described in paragraph (a)(2) of this Q&A a-4 must be taken into account 
by such alternate payee for purposes of calculating the excess 
distributions received by (or excess accumulations held by) the 
alternate payee.
    a-5: Q. If an annuity contract that represents an irrevocable 
commitment to provide an employee's benefits under the plan is 
distributed to an individual, how are the distribution of such annuity 
contract and distributions of amounts under such a contract taken into 
account for purposes of calculating excess distributions?
    A. Except to the extent that the value of an annuity contract is 
includible in income in the year the contract is distributed or any 
subsequent year, the distribution of an annuity contract (including a 
group annuity contract) in satisfaction of plan liabilities is 
disregarded for purposes of calculating excess distributions. Any 
amounts that are actually distributed under the contract to the 
individual (to the extent not excluded under Q&A a-4 of this section) or 
are otherwise includible in income with respect to the contract (e.g., 
by reason of the inclusion in income of the value of the annuity 
contract in the year of the contract's distribution or any subsequent 
year) are taken into account for purposes of calculating excess 
distributions for the calendar year during which such amounts are 
received or otherwise includible in income. For purposes of this Q&A a-
5, the term plan means any qualified employer plan or individual 
retirement plan specified in section 4981A(e) and Q&A a-3 of this 
section.
    a-6: Q. Are minimum distributions required under section 401(a)(9), 
408(a)(6), 408(b)(3) or 403(b)(10) taken into account to determine 
excess distributions?
    A. Yes. Distributions received during a calendar year are taken into 
account in determining an individual's excess distributions for such 
calendar year even though such distributions are required under section 
401(a)(9), 408(a)(6), 408(b)(3) or 403(b)(10). For example, minimum 
distributions under section 401(a)(9) received during the 1987 calendar 
year for calendar years 1985 and 1986 will be subject to section 4981A 
as distributions for 1987.
    a-7: Q. Are distributions of excess deferrals permitted under 
section 402(g)(2), or distributions of excess contributions or excess 
aggregate contributions permitted under section 401(k) or (m), or 
distributions of IRA

[[Page 340]]

contributions permitted under section 408(d) (4) or (5) taken into 
account for purposes of calculating excess distributions?
    A. No. Distributions of excess deferrals, excess contributions, 
excess aggregate contributions, distributions of IRA contributions, and 
income allocable to such contributions or deferrals, that are made in 
accordance with the provisions of sections 402(g)(2), 401(k)(8), 
401(m)(6), or 408(d) (4) or (5) are not taken into account for purposes 
of calculating excess distributions.
    a-8: Q. What distributions from qualified employer plans or 
individual retirement plans are taken into account in determining an 
individual's excess distributions?
    A. With the exception of distributions noted above in Q&As a-4, a-5, 
and a-7 of this section, all distributions from qualified employer plans 
or individual retirement plans must be taken into account in determining 
an individual's excess distributions for the calendar year in which such 
distributions are received. In general, all such distributions are taken 
into account whether or not they are currently includible in income. 
Thus, for example, net unrealized appreciation in employer securities 
described in section 402(a) is taken into account in the year 
distributed. However, health coverage or distributions of medical 
benefits provided under an arrangement described in section 401(h) that 
are excludible from income under section 104, 105, or 106 are not 
subject to section 4981A. In addition, distributions that are excludible 
from income because they are rolled over to a plan or an individual 
retirement account are not taken into account. (See Q&A a-4(a) (4) and 
(5) of this section). Amounts that are includible in income for a 
calendar year are treated as distributions and, thus, are taken into 
account even if the amounts are not actually distributed during such 
year. Thus, deemed distributions to provide insurance coverage 
includible in income under section 72 (PS-58 amounts), loan amounts 
treated as deemed distributions under section 72(p), and amounts 
includible under section 402(b) or section 403(c) by reason of the 
employer plan or individual retirement plan not being qualified during 
the year are taken into account.
    a-9: Q. Will the dollar threshold amount used to determine an 
individual's excess distributions be adjusted for inflation in calendar 
years after 1987?
    A. Beginning in 1988, the $112,500 threshold amount is adjusted to 
reflect post-1986 cost-of-living increases (COLAs) at the same time and 
in the same manner as the adjustment described in section 415(d). The 
threshold amount is adjusted even though the distribution is from a 
defined contribution plan that is subject to a freeze on COLAs because 
the defined benefit plan limit is below $120,000 (see section 
415(c)(1)(A)). However, the $150,000 threshold amount is not adjusted to 
reflect such increases.

                       b. Special Grandfather Rule

    b-1: Q. How are benefits accrued before TRA '86 treated under the 
excise tax provisions described in section 4981A?
    A. (a) Grandfather amount. Certain eligible individuals may elect to 
use a special grandfather rule that exempts from the excise tax the 
portion of distributions treated as a recovery of such individual's 
total benefits accrued on or before August 1, 1986 (grandfather amount). 
However, distributions that are treated as a recovery of the grandfather 
amount are taken into account in determining the extent to which other 
distributions are excess distributions (see Q&A b-4 of this section). 
Under this special grandfather rule, the grandfather amount equals the 
value of an individual's total benefits (as described in Q&As b-8 and b-
9 of this section) in all qualified employer plans and individual 
retirement plans on August 1, 1986. An individual's benefits in such 
plans include amounts determinable on August 1, 1986, that are payable 
to the individual under a qualified domestic relations order within the 
meaning of section 414(p) (QDRO). However, QDRO benefits that, when 
destributed, are includible in the income of the alternate payee are not 
included in the employee's grandfathered amount. Further, plan benefits 
that

[[Page 341]]

are attributable to a deceased individual and that are payable to an 
eligible individual as a beneficiary are generally not included in 
determining the eligible individual's grandfather amount. Procedures for 
determining the grandfather amount are described in Q&As b-11 through b-
14 of this section.
    (b) Recovery of grandfather amount. The portion of any distribution 
made after August 1, 1986, that is treated as a recovery of a 
grandfather amount depends on which of two grandfather recovery methods 
the individual elects. The two alternative methods are described in the 
Q&As b-11 through b-14 of this section. The amount of the distribution 
for a year that is treated as a recovery of a grandfather amount in a 
year is applied to reduce the individual's unrecovered grandfather 
amount for future years (i.e., the individual's accrued benefits as 
described in Q&As b-8 and b-9 on August 1, 1986, reduced by previous 
distributions treated as a recovery of a grandfather amount) on a dollar 
for dollar basis until the individual's unrecovered grandfather amount 
has been reduced to zero. When the individual's grandfather amount has 
been reduced to zero, the special grandfather rule ceases to apply and 
the entire amount of any subsequent excess distributions received is 
subject to the 15 percent excise tax.
    b-2: Q. Who may elect to use the special grandfather rules?
    A. Any individual whose accrued benefits as described in Q&As b-8 
and b-9 of this section in all qualified plans and individual retirement 
plans on August 1, 1986 (initial grandfather amount) have a value of at 
least $562,500 may elect to use the special grandfather rule.
    b-3: Q. How does an eligible individual make a valid election to use 
the special grandfather rule?
    A. (a) Form of election. An individual who is eligible to use the 
special grandfather rule must affirmatively elect to use that rule. The 
election is made on a Form 5329 filed with the individual's income tax 
return (Form 1040, etc.) for a taxable year beginning after December 31, 
1986, and before January 1, 1989 (i.e., the 1987 or 1988 taxable year).
    (b) Information required. The individual must report the following 
information on the Form 5329:
    (1) The individual's initial grandfather amount.
    (2) The grandfather recovery method to be used.
    (3) Such other information as is required by the Form 5329.
    (c) Deadline for election. The deadline for filing such election is 
the due date, calculated with extensions, for filing the individual's 
1988 income tax return. If an individual dies before the expiration of 
such deadline, an election, or the revocation of a prior election, may 
be made as part of the final income tax return filed on behalf of such 
deceased individual by the deceased individual's personal 
representative. An election or revocation of a prior election may also 
be filed before the expiration of such deadline with Schedule S (Form 
706). See Q&A c-7 of this section.
    (d) Revocation of election. Elections filed before the deadline may 
be revoked by filing an amended income tax return for any applicable 
year. A change in the grandfather recovery method is considered a 
revocation of a prior election and an amended Form 5329 must be filed 
for any prior year in which a different grandfather recovery method was 
used. Thus, a change in the election may require a change in the 1987 
tax return. An individual must refile for 1987 based on the new election 
if additional tax is owed. However, an election (or nonelection) is 
irrevocable after the filing deadline for the taxable year beginning in 
1988 has passed. Thus, an individual who has not made an election by the 
last day plus extensions for filing the 1988 return may not do so 
through an amended return.
    (e) Subsequent years. (1) Any eligible individual who has elected 
the special grandfather rule must attach to the individual's income tax 
return for all subsequent taxable years in which the individual receives 
excess distributions (determined without regard to the grandfather rule) 
a copy of the Form 5329 on which the individual elected the grandfather 
rule. A copy of the Form 5329 on which the individual (or the 
individual's personal representative) elected the grandfather rule must 
also

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be filed with Schedule S (Form 706) unless the initial election is filed 
with such schedule.
    (2) The individual must also make such other reports in the form and 
at the time as the Commissioner may prescribe. See Q&A c-7 of this 
section for the applicable reporting requirements if the individual or 
the individual's estate is liable for any tax on excess distributions or 
on an excess accumulation under section 4981A (a) or (d).
    b-4: Q. How individuals who have elected to use the special 
grandfather rule determine the extent to which their distributions for 
any calendar year are excess distributions?
    A. (a) Excess distributions under grandfather rule, threshold 
amount. Individuals who elect to use the special grandfather rule are 
not eligible to use the $150,000 threshold amount in computing their 
excess distributions for any calendar year. Instead, such electing 
individuals must compute their excess distributions for a calendar year 
using a $112,500 (indexed for cost-of-living increases) threshold 
amount. The rule of this paragraph (a) applies for all calendar years, 
including the calendar year in which an individual's unrecovered 
grandfather amount has been reduced to zero and all subsequent calendar 
years. Once the indexed amount has increased to $150,000 or more, the 
threshold amount will be the same for all individuals.
    (b) Base for excise tax under grandfather rule. Although the portion 
of any distribution that is treated as a recovery of an individual's 
grandfather amount is not subject to the excise tax, such portion must 
be taken into account in determining the extent to which the individual 
has excess distributions for a calendar year. The effect of this rule is 
that the amount against which the 15 percent excise tax is applied for 
any calendar year during which a grandfather amount is recovered equals 
the individual's distributions for such year reduced by the greater of 
(1) the applicable threshold amount for such year or (2) the grandfather 
amount recovered for such year. (See the examples in Q&A b-14 of this 
section.)
    b-5: Q. How is the value of an individual's total accrued benefits 
on August 1, 1986, calculated for purposes of determining (a) whether an 
individual is eligible to elect the special grandfather rule and (b) the 
amount of any electing individual's initial grandfather amount under 
such rule?
    A. (a) Introduction. The value of an individual's total accrued 
benefits on August 1, 1986, is the sum of the values of the individual's 
accrued benefits on such date under all qualified employer plans or 
individual retirement plans, as determined under the Q&A b-5. If such 
value exceeds $562,500, the individual may elect the special grandfather 
rule. In such case, the value so determined may be applied against 
distributions as determined under this section, whether or not such 
distributions are from the same plan or IRA for which such grandfather 
amount is determined. For purposes of determining the value of accrued 
benefits on August 1, 1986, an annuity contract or an individual's 
interest in a group annuity contract described in Q&A a-5 of this 
section is treated as an accrued benefit under the qualified retirement 
plan or IRA from which it was distributed and an IRA is treated as a 
defined contribution plan.
    (b) Defined benefit plan--(1) General rule. The amount of an 
individual's accrued benefit on August 1, 1986, under a defined benefit 
plan is determined as of that date under the provisions of the plan 
based on the individual's service and compensation on that date. The 
present value of such benefit is determined by an actuarial valuation of 
such accrued benefit performed as of August 1, 1986. Alternatively, 
accrued benefits may be determined as of July 31, 1986. In such case, 
the applicable rules are applied by substituting the July 31 date for 
the August 1 date in the applicable provisions. (See Q&A b-9 of this 
section for rules for determining the amount of benefits and values and 
the actuarial assumptions to be used in such determination.)
    (2) Alternative method. Alternatively, the present value of an 
individual's accrued benefit on August 1, 1986, may be determined using 
the following method:
    (i) Determine the amount of the individual's actual accrued benefit 
(prior benefit) on the valuation date that immediately precedes August 
1, 1986

[[Page 343]]

(prior date). The valuation date for purposes of using this alternative 
method is the valuation date used for purposes of section 412. In making 
this determination, plan amendments that are adopted after that prior 
date are disregarded.
    (ii) Determine the amount of the individual's adjusted accrued 
benefit (adjusted prior benefit) on the prior date by reducing the prior 
benefit in paragraph (b)(2)(i) of this Q&A b-5 by the amount of 
distributions that reduce the accrued benefit or transfers from the plan 
and by increasing the prior benefit in paragraph (b)(2)(i) of this Q&A 
b-5 by any increase in benefit resulting from either transfers to the 
plan or plan amendments that were made (or, in the case of a plan 
amendment, both adopted and effective) after the prior valuation date, 
but on or before August 1, 1986.
    (iii) Determine the amount of the individual's actual accrued 
benefit (future benefit) on the valuation date immediately following 
August 1, 1986 (next date). In making this determination, plan 
amendments, etc. that are either adopted or effective after August 1 are 
disregarded.
    (iv) Determine the amount of the individual's adjusted accrued 
benefit (adjusted future benefit) on the next date by increasing the 
future benefit in paragraph (b)(2)(iii) of this Q&A b-5 by the amount of 
any distributions that reduce the accrued benefit or transfers from the 
plan and by reducing the future benefit in paragraph (b)(2)(iii) of this 
Q&A b-5 by the amount of any transfer to the plan that was made after 
August 1, 1986, but on or before the next valuation date to the amount 
in paragraph (b)(2)(iii) of this Q&A b-5.
    (v) Calculate the weighted average of paragraphs (b)(2)(ii) and 
(b)(2)(iv) of this Q&A b-5, where the weights applied are the number of 
complete calendar months separating the applicable prior date and the 
applicable next date, respectively, and August 1, 1986.
    (vi) Determine the actuarial present value of the benefit in 
paragraph (b)(2)(v) of this Q&A b-5 as of August 1, 1986, using the 
methods and assumptions described in Q&A b-9 of this section.
    The grandfather amount on August 1, 1986, attributable to the 
accrued benefits under the defined benefit plan is equal to the amount 
determined in paragraph (b)(2)(vi) of this Q&A b-5.
    (3) Certain insurance plans treated as defined contribution plans. 
(i) Accrued benefits not in pay status under a plan satisfying the 
requirements of section 411(b)(1)(F) are determined under the rules in 
paragraph (c) of this Q&A b-5 for defined contribution plans. For 
purposes of applying paragraph (c) of this Q&A b-5 to such benefits, the 
cash surrender value of the contract is substituted for the account 
balance. If accrued benefits are in pay status under such a plan, the 
rules of this paragraph (b) apply to such benefits.
    (ii) Accrued benefits not in pay status that are attributable to 
voluntary employee contributions (including rollover amounts) to a 
defined benefit plan are determined under the rules in paragraph (c) of 
this Q&A b-5 as if the account balance attributable thereto is under a 
defined contribution plan. If such benefits are in pay status and are 
used to fund the benefit under the defined plan, the rules of this 
paragraph (b) apply to such benefits.
    (c) Defined contribution plan--(1) General rule. The value of an 
individual's accrued benefit on August 1, 1986, under a defined 
contribution plan (including IRAs) is the value of the individual's 
account balance on such date (or on the immediately preceding day). 
Paragraph (b)(3) of this Q&A b-5 requires that benefits derived from 
certain insured plans and from voluntary contributions to a defined 
benefit plan be determined under the rules of this paragraph (c).
    (2) Alternative method. Alternatively, if a valuation was not 
performed as of August 1, 1986 (or as of the immediately preceding day), 
the value of an individual's accrued benefit may be determined as 
follows:
    (i) Determine the value of the individual's account balance on the 
valuation date immediately preceding August 1, 1986 (prior valuation 
date).
    (ii) Determine the value of the individual's adjusted account 
balance on the prior valuation date by subtracting (or adding, 
respectively) the amount of any distribution, including a transfer

[[Page 344]]

to another plan or a forfeiture from the account balance (or the amount 
of any allocation to the account balance, including a transfer from 
another plan, rollover received or forfeiture from another account) that 
was made after the prior valuation date but on or before August 1, 1986, 
from (or to) the amount in paragraph (c)(2)(i) of this Q&A b-5.
    (iii) Determine the value of the individual's account balance on the 
valuation date immediately following August 1, 1986 (next valuation 
date).
    (iv) Determine the value of the individual's adjusted account 
balance on the next valuation date by adding (or subtracting, 
respectively) the amount of any distribution, of a type described in 
paragraph (c)(2)(ii) of this Q&A b-5 (or the amount of any allocation to 
the account balance, of a type described in paragraph (c)(2)(ii) of this 
Q&A b-5), that was made after August 1, 1986, but on or before the next 
valuation date to (or from) the amount in paragraph (c)(2)(iii) of this 
Q&A b-5.
    (v) Calculate the weighted average of paragraphs (c)(2)(ii) and 
(c)(2)(iv) of this Q&A b-5, where the weights applied are the number of 
complete calendar months separating the applicable valuation date and 
the applicable next date, respectively, and August 1, 1986.
    The grandfather amount on August 1, 1986, attributable to the 
account balance in the defined contribution plan or the individual 
retirement plan is the amount in paragraph (c)(2)(v) of this Q&A b-5.
    b-6: Q. For purposes of determining the value of accrued benefits in 
a defined contribution plan or a defined benefit plan on August 1, 1986, 
are nonvested benefits taken into account?
    A. Yes. All accrued benefits, whether or not vested, are taken into 
account.
    b-7: Q. To what extent are benefits payable with respect to an 
individual under a qualified employer plan or an individual retirement 
plan not taken into account for purposes of calculating the individual's 
grandfather amount?
    A. (a) Exclusions. The following benefits payable with respect to an 
individual are not taken into account for purposes of this calculation:
    (1) Benefits attributable to investment in the contract as defined 
in section 72(f). However, amounts attributable to deductible employee 
contributions (as defined in section 72(o)(5)(A)) are considered part of 
the accrued benefit.
    (2) Amounts that are determinable on August 1, 1986, as payable to 
an alternate payee who is required to include such amounts in gross 
income (a spouse or former spouse) under a qualified domestic relations 
order (QDRO) within the meaning of section 414(p).
    (3) Amounts that are attributable to IRA contributions that are 
distributed pursuant to section 408(d) (4) or (5).
    (b) Alternate payee. Under a QDRO described in paragraph (a)(2) of 
this Q&A b-7, amounts are considered part of the accrued benefit of the 
alternate payee for purposes of calculating the value of the alternate 
payee's accrued benefit on August 1, 1986. Similarly, such amounts are 
used by the alternate payee to compute excess distributions.
    b-8: Q. What adjustments to the grandfather amount are necessary to 
take into account rollovers from one qualified employer plan or 
individual retirement plan to another such plan?
    A. (a) Rollovers outstanding on valuation date. Generally, rollovers 
between plans result in adjustment to the grandfather amounts under the 
rules in Q&A b-5 of this section. However, if a rollover amount is 
distributed from one plan on or before an applicable valuation date of 
such plan and is rolled over into the receiving plan after the receiving 
plan's applicable valuation date and if these events result in an 
inappropriate duplication or omission of the rollover amount, then an 
adjustment to the grandfather amount must be made to remove the 
duplication or omission. The Commissioner may provide necessary rules 
concerning this adjustment.
    (b) Valuation. If the rollover amount described in paragraph (a) of 
this Q&A b-8 is in a form of property other than cash, the property of 
which the outstanding rollover consists is valued as of the date the 
rollover contribution is received by the transferee qualified employer 
plan or individual retirement plan and that value is the amount of the 
rollover. If the outstanding rollover is in the form of cash, the amount

[[Page 345]]

of the cash is the amount of the rollover.
    b-9: Q. What is the form of the grandfather benefit under a defined 
benefit plan and how is it valued?
    A. (a) Benefit form. The grandfather amount under a defined benefit 
plan is determined on the basis of the form of benefit (including any 
subsidized form of benefit such as a subsidized early retirement benefit 
or a subsidized joint and survivor annunity) provided under the plan as 
of August 1, 1986 that has the greatest present value as determined in 
paragraph (b) of this b-9. If the plan provides a subsidized joint and 
survivor annunity, for purposes of determining the grandfather amount, 
it will be assumed that an unmarried individual is married and that the 
individual spouse is the same age as the individual. Assumptions as to 
future withdrawals, future salary increases or future cost-of-living 
increases are not permitted.
    (b) Value of grandfather amount. The grandfather amount under a 
defined benefit plan is the present value of the individual's benefit 
form determined under paragraph (a) of this Q&A b-9. Thus, the benefit 
form is reduced to reflect its value on the applicable valuation date. 
The present value of the benefit form on August 1, 1986, or the 
applicable date, is computed using the factors specified under the terms 
of the plan as in effect on August 1, 1986, to calculate a single sum 
distribution if the plan provides for such a distribution. If the plan 
does not provide for such a distribution form, such present value is 
computed using the interest rate and mortality assumptions specified in 
Sec. 20.2031-7 of the Estate Tax Regulations.
    b-10: Q. Is the plan administrator (or trustee) of a qualified plan 
(or individual retirement account) required to report to an individual 
the value of the individual's benefit under the plan as of August 1, 
1986?
    A. (a) Request required. No report is required unless the individual 
requests a report and the request is received before April 15, 1989. If 
requested, the plan administrator (or trustee or issuer) must report to 
such individual the value of the individual's benefit under the plan as 
of August 1, 1986, determined in accordance with Q&A b-5 through b-9 of 
this section. Such report must be made within a reasonable time after 
the individual's request but not later than July 15, 1989.
    (b) Other rules. Alternate payees must make their own request for 
valuation reports. Any report furnished to an employee who has an 
alternate payee with respect to the plan must include the separate 
values attributable to each such individual. Any report furnished to an 
alternate payee must include only the value attributable to the 
alternate payee. Reports may be furnished to individuals even if no 
request is made. Individuals must keep records of the reports received 
from plans or IRAs in order to substantiate all grandfather amounts.
    (c) Authority. The rules in this Q&A are provided under the 
authority in section 6047(d).
    b-11: Q. How is the portion of a distribution that is treated as a 
recovery of an individual's grandfather amount as described in b-1 of 
this section to be calculated?
    A. (a) General rule. All distributions received between August 1 and 
December 31, 1986, inclusive, are treated as a recovery of a grandfather 
amount. The portion of distributions received after December 31, 1986, 
that is treated as a recovery of the grandfather amount is determined 
under either the discretionary method or the attained age method. An 
amount that is treated as a recovery of grandfather benefits is applied 
to reduce the initial grandfather amount that was calculated as of 
August 1, 1986, on a dollar for dollar basis until the unrecovered 
amount has been reduced to zero. No other recalculation of the 
grandfather amount is to be made for a date after August 1, 1986.
    (b) Methods, etc. The grandfather amount may be recovered by an 
individual under either the discretionary method or the attained age 
method. After the individual's total grandfather amount is treated as 
recovered under either method, the tax on excess distributions and 
excess accumulations is determined without regard to any grandfather 
amount.

[[Page 346]]

    b-12: Q. Under the discretionary method, what portion of each 
distribution is treated as a return of the individual's grandfather 
amount?
    A. (a) Initial percentage. Under the discretionary method, unless 
the individual elects in accordance with paragraph (b) below, 10 percent 
of the total distributions that the individual receives during any 
calendar year is treated as a recovery of the grandfather amount.
    (b) Acceleration. The individual may elect to accelerate the rate of 
recovery to 100 percent of the total aggregate distributions received 
during a calendar year commencing with any calendar year, including 1987 
(acceleration election). In such case, the rate of recovery is 
accelerated to 100 percent for the calendar year with respect to which 
the election is made and for all subsequent calendar years.
    (c) Election. To recover the grandfather amount using the 
discretionary method, an individual must elect to use such method when 
making the election to use the special grandfather rule on the Form 
5329. (See Q&A b-3 of this section.) The acceleration election must be 
made for the individual's taxable year beginning with or within the 
first calendar year for which such election is made and must be filed 
with the individual's income tax return for that year. Such acceleration 
election may also be made or revoked retroactively on an amended return 
for such year. However, the acceleration election may not be made after 
the individual's death other than with the individual's final income tax 
return or with a return for a prior year for which a return was not 
filed before the individual's death. Thus, the acceleration election may 
not be made on an amended return filed after the individual's death for 
a year for which a return was filed before the individual's death. The 
preceding two sentences shall not apply to deaths occurring in 1987 or 
1988. The estate is entitled to use the remaining grandfather amount to 
determine if there is an excess accumulation. See Q&A d-3 of this 
section. The acceleration election shall be made on such form and in 
such manner as the Commissioner prescribes in a manner consistent with 
the rules of this section.
    b-13: Q. Under the attained age method, what portion of each 
distribution is treated as a return of the individual's grandfather 
amount?
    A. Under the attained age method, the portion of total distributions 
received during any year that is treated as a recovery of an 
individual's grandfather amount is calculated by multiplying the 
individual's aggregate distributions for a calendar year by a fraction. 
The numerator of the fraction is the difference between the individual's 
attained age in completed months on August 1, 1986, and the individual's 
attained age in months at age 35 (420 months). The denominator of the 
fraction is the difference between the individual's attained age in 
completed months on December 31 of the calendar year and the 
individual's attained age in months at age 35 (420 months). An 
individual whose 35th birthday is after August 1, 1986, may not use the 
attained age method.
    b-14: Q. How is the 15 percent tax with respect to excess 
distributions for a calendar year calculated by an individual who has 
elected to use the special grandfather rule?
    A. The calculation of the excise tax may be illustrated by the 
following examples:

    Example 1. (a) An individual (A) who participates in two retirement 
plans, a qualified defined contribution plan and a qualified defined 
benefit plan, has a total value of accrued benefits on August 1, 1986 
under both plans of $1,000,000. Because this amount exceeds $562,500, A 
is eligible to elect to use the special grandfather rule to calculate 
the portion of subsequent distributions that are exempt from tax. A 
elects to use the discretionary grandfather recovery method and attaches 
a valid election to the 1987 income tax return. A does not elect to 
accelerate the rate of recovery for 1987. On October 1, 1986, A receives 
a distribution of $200,000. On February 1, 1987, A receives a 
distribution of $45,000 and, on November 1, 1987, receives a 
distribution of $200,000. The 15 percent excise tax applicable to 
aggregate distributions in 1987 is calculated as follows:

(1) Value of grandfather amount on 8/1/86.....................$1,000,000
(2) Grandfather amounts recovered in 1986 but after 8/1/86......$200,000
(3) Value of grandfather amount on 12/31/86 ((1)-(2))...........$800,000
(4) Grandfather recovery percentage..................................10%
(5) Distributions between 1/1/87 and 12/

[[Page 347]]

31/87 ($45,000x$200,000)........................................$245,000
(6) Portion of (5) exempt from tax ((4)x(5)).....................$24,500
(7) Amount potentially subject to tax ((5)-(6)).................$220,500
(8) Portion of aggregate distributions in excess of $112,500 
($45,000x$200,000-$112,500).....................................$132,500
(9) Amount subject to tax (lesser of (7) and (8))...............$132,500
(10) Amount of tax (15% of (9))..................................$19,875
(11) Remaining undistributed value of grandfather amount as of 12/31/87 
((3)-(6)).......................................................$775,500

    (b) In 1988, A receives no distributions from either plan. On 
February 1, 1989, A receives a distribution of $300,000 and on December 
31, 1989, receives a distribution of $75,000. A makes a valid 
acceleration election for the 1989 taxable year, whereby A accelerates 
the rate of grandfather recovery that will apply for calendar years 
after 1988 to 100 percent. Assume the annual threshold amount for the 
1989 calendar year is $125,000 (i.e., 112,500 indexed). The 15 percent 
excess tax applicable to distributions in 1989 is calculated as follows:

(1) Value of grandfather amount on 8/1/86.......................$775,500
(2) Grandfather recovery percentage designated for 1989 calendar year 
                                                                    100%
(3) Distributions between 1/1/89 and 12/31/89 ($300,000x$75,000) 
                                                                $375,000
(4) Portion of (3) exempt from tax (2)x(3)......................$375,000
(5) Amount potentially subject to tax ((3)-(4)).......................$0
(6) Portion of aggregate distributions in excess of $125,000 
($300,000x$75,000-$125,000).....................................$250,000
(7) Amount subject to tax (lesser of (5) and (6)).....................$0
(8) Amount of tax (15% of (7))........................................$0
(9) Remaining undistributed value of grandfather amount as of 12/31/89 
((1)-(4)).......................................................$400,500

    The entire amount of any distribution for subsequent calendar years 
will be treated as a recovery of the grandfather amount and applied 
against the grandfather amount until the unrecovered grandfather amount 
is reduced to zero.
    Example 2. The facts are the same as in Example 1 except that A 
elects to use the attained age recovery method and A makes a valid 
election for the 1987 taxable year. Further assume that A's attained age 
in months on August 1, 1986 is 471 months and on December 31, 1987, is 
488 months. The 15 percent excise tax applicable to aggregate 
distributions in 1987 is calculated as follows:

(1) Value of grandfather amount on 8/1/86.....................$1,000,000
(2) Grandfather amounts recovered in 1986 but after 8/1/86......$200,000
(3) Value of grandfather amount on 12/31/86 ((1) - (2)).........$800,000
(4) Completed months of age in excess of 420 on 8/1/86................51
(5) Completed months of age in excess of 420 on 12/31/87..............68
(6) Grandfather fraction as of 12/31/86 ((4) divided by (5)).......\3/4\
(7) Distributions between 1/1/87 and 12/31/87 ($45,000 + $200,000) 
                                                                $245,000
(8) Portion of (7) exempt from tax ((6)x(7))....................$183,750
(9) Amount potentially subject to tax ((7)-(8))..................$61,250
(10) Portion of aggregate distributions in excess of $112,500 ($45,000 + 
$200,000 - $112,500)............................................$132,500
(11) Amount subject to tax (lesser of (9) and (10))..............$61,250
(12) Amount of tax (15% of (11)...................................$9,187
(13) Unrecovered grandfather amount as of 12/31/87 ((3) - (8)) 
                                                                $616,250

                            c. Special Rules

    c-1: Q. How is the excise tax computed if a person elects special 
tax treatment under section 402 or 403 for a lump sum distribution?
    A. (a) General rule--(1) Conditions. Section 4981A(c)(4) provides 
for a special tax computation that applies to an individual in a 
calendar year if the individual receives distributions that include a 
lump sum distribution and the individual makes certain elections under 
section 402 or 403 with respect to that lump sum distribution (lump sum 
election).
    (2) Lump sum election. A lump sum election includes an election of 
(i) 5-year income averaging under section 402(e)(4)(B); (ii) phaseout 
capital gains treatment under sections 402(a)(2) or 403(a)(2) prior to 
their repeal by section 1122(b) of TRA '86 and as permitted under 
section 1122(h)(4) of TRA `86; (iii) grandfathered long-term capital 
gains under sections 402(a)(2) and 403(a) prior to such repeal and as 
permitted by section 1122(h)(3) of TRA '86; and (iv) grandfathered 10-
year income averaging under section 402(e) (including such treatment 
under a section 402(e)(4)(L) election) prior to amendment by section 
1122(a) of TRA '86 and as permitted by section 1122(h)(3)(A)(ii) and (5) 
of the TRA '86.
    (3) Special tax computation. (i) If the conditions in paragraph 
(a)(1) of this Q&A c-1 are satisfied for a calendar year, the rules of 
this subparagraph

[[Page 348]]

(a)(3) apply for purposes of determining whether there are excess 
distributions and tax under section 4981A.
    (ii) All distributions are divided into two categories. These two 
categories are the lump sum distribution and other distributions. 
Whether or not a particular distribution is a distribution subject to 
section 4981A and is in either category is determined under the rules in 
section 4981A and this section. Thus, the exclusions under section 
4981A(c)(2) and Q&A a-4(a) of this section apply here. For example, a 
distribution that is a tax-free recovery of employee contributions is 
not in either category.
    (iii) The excise tax under section 4981A(c)(1) is computed in the 
normal manner except that (A) it is the sum of the otherwise applicable 
taxes determined separately for the two categories of excess 
distributions and (B) a different amount (threshold amount) is 
subtracted from the distributions in each category in determining the 
amount of the excess distributions. The threshold amount that is 
subtracted from the portion of the distributions that is not part of the 
lump sum distribution is the applicable threshold amount, determined 
without regard to section 4981A(c)(4) and the lump sum election. Thus, 
the threshold amount subtracted from the amount in this category is 
either the $150,000 amount or the $112,500 amount (indexed). The 
threshold amount that is subtracted from the amount of the lump sum 
distribution is 5 times the applicable threshold amount as described 
above. Thus, the threshold amount subtracted from the lump sum 
distribution is $750,000 or 5 times $112,500 indexed (initially 
$562,500).
    (b) Grandfather rule--(1) In general. This paragraph (b) provides 
special rules where an individual makes both the grandfather election 
described in section 4981A(c)(5) and the lump sum election described in 
paragraph (a) of this Q&A c-1. See Q&A b-11 through 14 for other rules 
that apply to such grandfather election.
    (2) Discretionary method. If the individual uses the discretionary 
method, described in Q&As b-11 and 12 of this section, the applicable 
threshold amount is $112,500 (indexed). Under this method, the 
grandfather amount is recovered at a 10 percent or 100 percent rate in 
any calendar year and is offset separately against distributions in each 
category of distributions at the appropriate rate. If, for any calendar 
year, distributions are received in both categories and the total of the 
appropriate percentage (10 percent or 100 percent) of the distributions 
in each category exceed the unrecovered grandfathered account, then such 
grandfather amount must be recovered ratably from the distributions in 
each category. This rule applies even if the distributions in one 
category are less than the threshold amount for that category and the 
distributions in the other category exceed the threshold amount for that 
category.
    (3) Attained age method. If the individual uses the attained age 
method, described in Q&As b-11 and 13 of this section, the threshold 
amount is $112,500 (indexed). Under this method, to determine the 
portion of the distributions in each category that is treated as a 
recovery of the grandfather amount, the fraction described in Q&A b-13 
of this section is applied separately to the distributions in each 
category of distributions. If, for any calendar year, distributions are 
received in both categories and the total of the amounts of the 
distributions in each category that are treated as a recovery of the 
grandfather amount exceeds that undercovered grandfather amount, then 
such grandfather amount must be recovered ratably from the distributions 
in each category. This rule applies even if the distributions in one 
category are less than the threshold amount for that category and the 
distributions in the other category exceed the threshold amount for that 
category.
    (c) Amount in lump sum category. All amounts received from the 
employer that are required to be distributed to the individual in order 
to make a lump sum election described in paragraph (a) of this Q&A c-1 
are included in the lump sum category. Amounts are in the lump sum 
category even though they are not subject to income tax under the 
election. Thus, for example, the following amounts would be in the lump 
sum category: (1) Appreciation on employer securities received as part 
of

[[Page 349]]

a distribution for which a lump sum treatment is elected; and (2) 
amounts that are phased out when section 1122 of TRA '86 is elected. 
However, accumulated deductible employee contributions under the plan 
(within the meaning of section 72(o)(5)) are in the nonlump sum 
category.
    (d) Examples. The rules in this Q&A c-1 are illustrated by the 
following examples:

    Example (1). (a) On January 1, 199X, individual A who is age 65 and 
is a calendar year taxpayer receives a lump sum distribution described 
in section 402(e)(4)(A) from a qualified employer plan (Plan X). A 
receives no other distribution in 199X. A elects 5-year income averaging 
under section 402(e)(4)(B) and also elects section 402(e)(4)(L) 
treatment (treating pre-74 participation as post-1973 participation) on 
A's income tax return for 199X. Thus, A also makes the lump sum election 
described in paragraph (a)(2), above. For 199X, the $112,500 threshold 
amount indexed is $125,000. A does not make a grandfather election so 
that A's threshold amount is $150,000.
    (b) A's distribution from Plan X consists of cash in the amount of 
$800,000. A has a section 72(f) investment in the contract. A has over 
the years made after tax contributions to Plan X of $50,000. A's 
distributions subject to section 4981A equal $750,000 because of the 
exclusion of A's $50,000 after-tax contributions.
    (c) A's distributions consist solely of amounts in the lump sum 
category. A's threshold amount equals $750,000 under the rules of this 
paragraph (a)(iii), above, (5 times $150,000). Because A's threshold 
amount ($750,000) equals the amount of A's distribution from Plan X 
($750,000) no part of A's distribution from Plan X is treated as an 
excess distribution subject to the 15-percent excise tax.
    Example (2). (a) Assume the same facts as in Example (1), except 
that A receives an additional distribution from an individual retirement 
plan described in section 408(a) (IRA Y) in 199X of $150,000. A has made 
no nondeductible contributions to IRA Y and all of the $150,000 is a 
distribution subject to section 4981A.
    (b) A's distributions consist of two categories, the lump sum 
category (Plan X $750,000) and the other than lump sum category (IRA Y 
$150,000). A separate threshold amount is subtracted from A's IRA Y 
distribution. This threshold amount equals $150,000 under the rules of 
this paragraph (a)(3), above, the same initial threshold amount that is 
applied against the lump sum prior to the multiplication by 5). Because 
A's threshold amount ($150,000) equals the amount of A's distribution 
from IRA Y ($150,000), no part of A's distribution from IRA Y would be 
treated as an excess distribution subject to the 15-percent excise tax.
    Example (3). (a) Assume the same facts as in Example (2), except 
that A's distribution is $825,000 from Plan X, before reduction of 
$50,000 for employee contributions, instead of $800,000, so that A's 
distribution subject to section 4981A from Plan X is $775,000. A made a 
valid grandfather election. Therefore, the applicable threshold amount 
is $125,000 ($112,500 indexed for 199X). A's unrecovered grandfather 
amount as of the end of the year preceding 199X is $1,000,000 (A had a 
benefit under another retirement plan (Plan Z) on August 1, 1986, and 
A's account balance under Plan Z, which is a stock bonus plan, is 
$6,000,000 on January 1, 199X.) A also made a valid election of the 
discretionary method to recover A's grandfather amount.
    (b) If A recovers A's grandfather amount in 199X at the 10 percent 
rate, 10 percent of A's distributions that are in the lump sum category 
(Plan X $775,000) is treated as a recovery of A's grandfather amount. 
Similarly, 10 percent of A's distributions that are in the other than 
lump sum category (IRA Y $150,000) is treated as a recovery of A's 
grandfather amount. Thus, A's grandfather amount is reduced by $92,500 
($77,500 Plan X and $15,000 IRA Y) for the 199X calendar year and is 
$907,500 on January 1 of the year following 199X. Because the amounts of 
the distributions in each category that are treated as a recovery of 
grandfather amount are less than the applicable threshold amount for 
each category ($625,000 Plan X, $125,000 IRA Y), the recovery of the 
grandfather amount does not affect the calculations of the 199X excise 
tax.
    (c) Because A's distribution from IRA Y of $150,000 exceeds A's 
threshold amount of $125,000 ($112,500 indexed) applicable to nonlump 
sum distributions by $25,000 and A's distribution subject to section 
4981A from Plan X of $775,000 exceeds A's threshold amount of $625,000 
(5X$125,000) applicable to lump sums by $150,000, A is subject to the 
15-percent excise tax. A's tax under section 4981A is $26,250 (15 
percent of $25,000 plus 15 percent of $150,000).
    Example (4). (a) Assume the same facts as in Example (3) except that 
A makes a valid acceleration election under the discretionary method 
with respect to A's grandfather amount of $1,000,000 for calendar year 
199X.
    (b) Because A's grandfather amount on January 1, 199X ($1,000,000) 
equals or exceeds A's distribution subject to section 4981A ($925,000) 
for 199X, no part of A's distribution from Plan X or IRA Y would be 
treated as excess distribution subject to the 15-percent excise tax.
    (c) A's distributions subject to 4981A from Plan X of $775,000 and 
from IRA Y of $150,000 are offset 100 percent by A's grandfather

[[Page 350]]

amount of $1,000,000. Therefore, A's grandfather amount on January 1 of 
the year following 199X is $75,000 ($1,000,000 minus $925,000). This 
$75,000 would be required to be offset 100 percent against any 
distributions received in that year.
    Example (5). (a) Assume the same facts as in Example (4), except 
that A's distribution subject to section 4981A from Plan X, after 
reduction of the $50,000 for employee contributions, is $1,000,000 and 
from IRA Y is $125,000 (equal to the threshold amount), totaling 
$1,125,000.
    (b) Because the sum of the amount received in the lump sum category 
and the other than lump sum category of distributions is greater than 
the grandfather amount ($1,000,000), the grandfather amount must be 
allocated to each separate category on the basis of the ratio of the 
amount received in each category to the sum of these amounts. Thus, 
$888,889 ($1,000,000 X ($1,000,000 divided by $1,125,000)) is allocated 
to the lump-sum category and $111,111 ($1,000,000 X ($125,000 divided by 
$1,125,000)) is allocated to the other than lump sum category. A's 
distributions of $1,000,000 in the lump sum category are reduced by 
$888,889, the greater of $625,000 (the threshold amount) or $888,889 
(grandfather amount), and equal $111,111. A's excise tax is $16,666 (15 
percent of $111,111). A owes no excess distribution tax on the $125,000 
received from IRA Y because it is fully offset by the threshold amount 
of $125,000.
    (c) Because A's distribution subject to section 4981A for the year 
of $1,125,000 ($1,000,000 plus $125,000) exceeds A's grandfather amount 
on January 1, 199X of $1,000,000, A's grandfather amount is zero for all 
subsequent calendar years.

    c-2: Q. Must retirement plans be amended to limit future benefits 
accruals so that the amounts that are distributed would not be subject 
to an excise tax under section 4981A?
    A. No. A qualified employer plan need not be amended to reduce 
future benefits so that the amount of annual aggregate distributions are 
not subject to tax under section 4981A. Section 415 does, however, 
require plan provisions that limit the accrual of benefits and 
contributions to specified amounts. The operation of the excise tax of 
section 4981A is independent of plan qualification requirements limiting 
benefits and contributions under qualified plans.
    c-3: Q. Is a plan amendment reducing accrued benefits a permitted 
method of avoiding the excise tax?
    A. No. Accrued benefits may not be reduced to avoid the imposition 
of the excise tax. Such reduction would violate employer plan 
qualification requirements, including section 411(d)(6).
    c-4: Q. To what extent is the 15 percent section 4981A tax reduced 
by the 10 percent section 72(t) tax?
    A. (a) General rule. The 15 percent tax on excess distributions may 
be offset by the 10 percent tax on early distributions to the extent 
that the 10 percent tax is applied to excess distributions. For example, 
assume that individual (A), age 56, receives a distribution of $200,000 
from a qualified employer plan (Plan X) during calendar year 1987. 
Further, assume that the entire distribution is subject to the 10-
percent tax of section 72(t). A tax of $20,000 (10% of $200,000) is 
imposed on the distribution under section 72(t). Assuming that the 
distribution is not a lump sum distribution eligible for special tax 
treatment under section 402, part of the distribution is subject to tax 
under section 4981A. If A does not elect the special grandfather rule, 
A's dollar limitation is $150,000 and the amount of $200,000 
distribution that is an excess distribution is $50,000 ($200,000-
$150,000). The 15 percent tax is $7,500 (15% of $50,000). The portion of 
the $20,000 section 72(t) tax on early distributions that is 
attributable to the excess distribution is $5,000 (10% of $50,000). This 
amount is credited against the section 4981A tax. Therefore, the total 
tax imposed on the distribution under both provisions is $22,500 
($20,000 + ($7,500-$5,000)).
    (b) Example. (1) If some, but not all, distributions made for a 
calendar year are subject to the section 72(t) tax, the offset is 
applied only to the extent that the section 72(t) tax applies to amounts 
that exceed the applicable threshold amount for that calendar year. For 
example, assume that during 1987 individual B receives a distribution of 
$40,000 that is not subject to the 10 percent section 72(t) tax and a 
separate distribution of $160,000 that is subject to the 10 percent 
section 72(t) tax. A tax of $16,000 (10% of $160,000) is imposed by 
section 72(t). Excess distributions for the year, assuming B does not 
elect the special grandfather rule, are $50,000 ($40,000 + $160,000-
$150,000). The tax under section 4981A is $7,500 (15% of $50,000). For 
purposes of determining

[[Page 351]]

the extent to which the 10 percent tax is applied to excess 
distributions, the only amounts subject to the 10 percent tax that are 
taken into account are distributions in excess of $150,000 (or if 
greater, the $112,500 (indexed) threshold for the year). The amount of 
distributions for 1987 to which the 10 percent tax is applicable 
($160,000) exceeds $150,000 by $10,000. Thus, the portion of the section 
72(t) tax of $16,000 that is attributable to excess distributions equals 
$1,000 (10 percent of $10,000). This amount is credited against the 
section 4981A tax. The total tax payable under the provisions of 
sections 72(t) and 4981A is $22,500 ($16,000 + ($7,500-$1,000)).
    (c) Net unrealized appreciation. A distribution consisting of net 
unrealized appreciation of employer securities that is excluded from 
gross income is not subject to section 72(t) and, therefore, there is no 
section 72(t) tax on such distribution that may be used to offset the 
tax on excess distributions.
    c-5: Q. If a distribution that is subject to both the 10 percent tax 
on early distributions from qualified plans imposed under section 72(t) 
and the 15 percent tax on excess distributions imposed under section 
4981A is received by an individual who elects to calculate the 15 
percent tax using the special grandfather rule, how is the offset of the 
10 percent tax imposed under section 72(t) calculated?
    A. The section 4981A tax is reduced only by the amount of the 10 
percent tax that is attributable to the portion of the distribution to 
which the section 4981A tax applies. For example, assume that (a) an 
individual (A), age 57, receives during 199X a distribution from a 
qualified plan of $325,000 that is subject to the 10 percent section 
72(t) tax; (b) the distribution is not a lump sum distribution and is 
subject to the 15 percent excise tax imposed by section 4981A; (c) A has 
elected to use the special grandfather rule; and (d) A accelerates the 
rate of recovery of the remaining grandfather amount of $250,000 so that 
only $75,000 of this distribution is subject to the section 4981A tax. 
Thus, the section 4981A tax is $11,250 (15% of $75,000). The portion of 
the section 72(t) 10 percent tax that is offset against the section 
4981A tax of $11,250 is limited to $7,500 (10% of $75,000), the section 
72(t) tax on the amount of distributions after taking into account the 
reduction under the grandfather rule.
    c-6: Q. When do distributions become subject to the excise tax under 
section 4981A?
    A. (a) General rule. Excess distributions made after December 31, 
1986, are subject to the excise tax under section 4981A.
    (b) Transitional rule--(1) Termination. Distributions prior to 
January 1, 1988, made on account of certain terminations of a qualified 
employer plan are not subject to tax under section 4981A. For a plan 
termination to be eligible for this transitional rule, the plan 
termination must occur before January 1, 1987. For purposes of applying 
the rules of section 4981A (except the reporting requirements), any such 
distribution is treated as if made on December 31, 1986. The 
distribution of an annuity contract is not an excepted distribution. See 
Q&A a-5 of this section.
    (2) Lump sum distributions. A lump sum distribution that an 
individual who separates from service in 1986 receives in calendar year 
1987 before March 16 is treated as a distribution received in 1986 if 
such individual elects to treat it as received in 1986 under the 
provisions of section 1124 of TRA '86. Thus, such a qualifying section 
1124 distribution is not subject to tax under section 4981A for 1987. 
For purposes of applying the rules of section 4981A, the amount 
attributable to such distribution is included in the individual's August 
1, 1986 accrued benefit and such distribution is treated as if made on 
December 31, 1986.
    (3) Grandfather amount recovery. If an individual described in this 
paragraph elects the special grandfather rule, the entire amount of 
distributions described in subparagraph (1) or (2) of this paragraph (b) 
is treated as a recovery of the individual's grandfather amount because 
it is treated as received on December 31, 1986. Thus, the individual's 
outstanding grandfather amount as of the date of the distribution is 
reduced by the amount of such distribution.
    c-7: Q. How is the tax on excess distributions or on excess 
accumulations under section 4981A reported?

[[Page 352]]

    A. (a) Tax on excess distributions. An individual liable for tax on 
account on excess distributions under section 4981A must complete Form 
5329 and attach it to his income tax return for the taxable year 
beginning with or within the calendar year during which the excess 
distributions are received. The amount of the tax is reported on such 
form and in such manner as prescribed by the Commissioner.
    (b) Tax on excess accumulations--(1) General rule. If, with respect 
to the estate of any individual, there is a tax under section 4981A(d) 
on account of the individual's excess accumulations, the amount of such 
tax is reported on Schedule S (Form 706 or 706NR). Schedule S must be 
filed on or before the due date under section 6075 including extensions, 
for filing the estate tax return. The tax under section 4981A(d) must be 
paid by the otherwise applicable due date for paying the estate tax 
imposed by chapter 11 even if, pursuant to section 6018(a), no return is 
otherwise required with respect to the estate tax imposed by chapter 11.
    (2) Earliest due date. Notwithstanding paragraph (b)(1) of this c-7, 
the due date for filing Schedule S (Form 706) and paying the tax on 
excess accumulations under section 4981A(d) is not earlier than February 
1, 1988. Thus, with respect to the estates of individuals dying in 
January through April of 1987, the due date for filing Schedule S (Form 
706) and paying any tax owed under section 4981A(d) is not earlier than 
February 1, 1988, even if the due date for filing the Schedule 706 and 
paying the estate tax imposed by chapter 11 is an earlier date. Further, 
no interest or penalties will be charged for failure to pay any tax on 
excess accumulations under section 4981A before January 31, 1988.
    c-8: Q. Does the fact that the benefits under a qualified retirement 
plan or individual retirement account are community property affect the 
determination of the excise tax under section 4981A?
    A. Generally, no. The operation of community property law is 
disregarded in determining the amount of aggregate annual distributions. 
Thus, the excise tax under section 4981A is computed without regard to 
the spouse's community property interest in the individual's or 
decedent's distributions or accumulation. Also, any reporting to the 
individual by a trustee, must be done on an aggregate basis without 
regard to the community property law.

                         d. Excess Accumulations

    d-1: Q. To what extent does section 4981A increase the estate tax 
imposed by chapter 11 with respect to the estates of any decedents?
    A. Section 4981A(d) provides that the estate tax imposed by chapter 
11 with respect to the estate of any decedent is increased by an amount 
equal to 15 percent of the decedent's excess accumulation. See Q&A d-2 
through d-7 of this section for rules for determining the decedent's 
excess accumulation. See Q&A d-8 of this section concerning credits 
under section 2010 through 2016. See Q&A d-9 of this section for 
examples illustrating the determination of the increase in estate tax 
under section 4981A(d).
    d-2: Q. How is the amount of an decedent's excess accumulation 
determined?
    A. (a) General rule. A decedent's excess accumulation is the excess 
of (1) the aggregate value of the decedent's interests in all qualified 
employer plans and individual retirement plans (decedent's aggregate 
interest) as of the date of the decedent's death over (2) an amount 
equal to the present value of a hypothetical life annuity determined 
under Q&A d-7 of this section. If the personal representative for the 
individual's estate elects to value the property in the gross estate 
under section 2032, the applicable valuation date prescribed by section 
2032 shall be substituted for the decedent's date of death.
    (b) Other rules. See Q&A d-3 and d-4 of this section if the decedent 
or, where appropriate, the decedent's personal representative validly 
elects the special grandfather rule and has any unused grandfather 
benefit as of the date of his death. See Q&A d-5 and d-6 of this section 
to determine the decedent's aggregate interest.
    d-3: Q. Does the special grandfather rule apply for purposes of 
determining the amount of the decedent's excess accumulation?

[[Page 353]]

    A. Yes. If a decedent prior to death (or the decedent's personal 
representative after death) makes an election that satisfied the 
procedures in Q&A b-3 of this section, the special grandfather rule 
applies.
    d-4: Q. How is the decedent's excess accumulation determined if the 
special grandfather rule applies?
    A. If the special grandfather rule applies, the decedent's excess 
accumulation is the excess of (a) the decedent's aggregate interest 
(determined under Q&A d-5 of this section) over (b) the greater of (1) 
the decedent's remaining unrecovered grandfather amount as of the date 
of the decedent's death, or (2) an amount equal to the present value of 
a hypothetical life annuity under Q&A d-7 of this section.
    d-5. Q. How is the value of the decedent's aggregate interest as of 
the applicable valuation date under Q&A d-2 determined?
    A. (a) Method of valuation. The value of the decedent's aggregate 
interest on the decedent's date of death is determined in a manner 
consistent with the valuation of such interests for purposes of 
determining the individual's gross estate for purposes of chapter 11. If 
the personal representative for an individual's estate subject to estate 
tax elects to value the property in the gross estate under section 2032, 
the decedent's aggregate interest is valued in a manner consistent with 
the rules prescribed by section 2032 (and other relevant estate tax 
sections). No adjustments provided in chapter 11 in valuing the gross 
estate are made. Thus, there is no adjustment under section 2057 
(relating to the sale of certain employer securities).
    (b) Amounts included. Generally, all amounts payable to 
beneficiaries of the decedent under any qualified employer plan 
(including amounts payable to a surviving spouse under a qualified joint 
and survivor annuity or qualified preretirement survivor annuity) or 
individual retirement plan, whether or not otherwise included in valuing 
the decedent's gross estate, are considered to be part of the decedent's 
interest in such plan.
    (c) Rollover after death. If any amount is distributed from a 
qualified employer plan or individual retirement plan within the 60-day 
period ending on the decedent's date of death and is rolled over to an 
IRA after such date but within 60 days of the date distributed, the 
decedent's aggregate interest is increased by the amount rolled over, 
valued as of the date received by the IRA.
    d-6. Q. Are there any reductions in the decedent's aggregate 
interest?
    A. The decedent's aggregate interest is reduced by the following:
    (a) Amount payable to alternate payee. The amount of any portion of 
the deceased individual's interest in a qualified employer plan that is 
payable to an alternate payee in whose income the amount is includible 
under a qualified domestic relations order within the meaning of section 
414(p) (QDRO). However, such portion must be taken into account in 
determining the excess distribution or the excess accumulation upon the 
death of such alternate payee for purposes of determining if there is a 
tax under section 4981A(a) or an increase in the estate tax under 
section 4981A(d) with respect to such alternate payee.
    (b) Investment in the contract. The amount of the deceased 
individual's unrecovered investment, within the meaning of section 
72(f), in any qualified employer plan or individual retirement plan.
    (c) Life insurance proceeds. The excess of any amount payable by 
reason of the death of the individual under a life insurance contract 
held under a qualified employer plan over the cash surrender value of 
such contract immediately before the death of such individual (the 
amount excludible from income by reason of section 101(a)). Amounts 
excludible from gross income because of section 101(b) do not reduce the 
decedent's aggregate interest.
    (d) Interest as a beneficiary. The amount of the deceased 
individual's interest in a qualified retirement plan or individual 
retirement plan by reason of the death of another individual.
    d-7. Q. How is the present value of the hypothetical life annuity 
determined?
    A. (a) General rule. The hypothetical life annuity is a single life 
annuity contract that provides for equal annual annuity payments 
commencing on the

[[Page 354]]

decedent's date of death for the life of an individual whose age is the 
same as the decedent's determined as of the date of the decedent's 
death. The amount of each annual payment is equal to the greater of 
$150,000 (unindexed) and $112,500 (as indexed until the date of death). 
If the decedent elected (or the decedent's personal representative 
elects) the special grandfather rule, the amount of each annual payment 
is $112,500 (as indexed until the date of death) even if there is no 
remaining grandfather amount.
    (b) Determination of age. The decedent's age as of the decedent's 
date of death for purposes of valuing the hypothetical life annuity is 
the decedent's attained age (in whole years) as of the decedent's date 
of death. For example, if the decedent was born on February 2, 1930, and 
died on August 3, 1990, the decedent's age for purposes of valuing the 
hypothetical life annuity is 60.
    (c) Interest rate assumptions. The present value of the single life 
annuity described above must then be calculated using the interest rate 
and mortality assumptions in Sec. 20.2031-7 of the Estate Tax 
Regulations in effect on the date of death.
    d-8: Q. Are any credits, deductions, exclusions, etc. that apply for 
estate tax purposes allowable as an offset against the excise tax under 
section 4981A(d) for excess accumulations?
    A. No. No credits, deductions, exclusions, etc. that apply for 
estate tax purposes are allowed to offset the tax imposed under section 
4981A(d). Thus, no credits under section 2010 through 2016 or other 
reductions permitted by Chapter 11 are allowable against the tax under 
section 4981A(d) for excess accumulations. For example, no credits are 
allowable for the unified credit against the estate tax, for state death 
taxes, or for gift taxes.
    d-8A. Q. Is the estate liable for the excise tax of 15 percent on 
the amount of the decedent's excess accumulations?
    A. Yes. In all events, the estate is liable for the excise tax of 15 
percent on the amount of the decedent's excess accumulations. Transferee 
liability rules under chapter 11 do apply, however. Similarly, the 
reimbursement provisions of section 2205 also apply. Additionally, the 
rules generally applicable for purposes of determining the apportionment 
of the estate tax apply to the apportionment of the excise tax under 
section 4981A(d). Thus, the decedent's will or the applicable state 
apportionment law may provide that the executor is entitled to recover 
the tax imposed under section 4981A(d) attributable to any property from 
the beneficiary entitled to receive such property. However, absent such 
a provision in the decedent's will or in the applicable state 
apportionment law, the executor is not entitled to recover the tax 
imposed under section 4981A(d) attributable to any property from the 
beneficiary entitled to receive such property.
    d-9: Q. How is the additional tax computed with respect to a 
decedent's estate under section 4981A(d)?
    A. The determination of the additional tax under section 4981A(d) is 
illustrated by the following examples:

    Example 1. (a) An individual (A) dies on February 1, 199X at age 70 
and 9 months. As of A's date of death, A has an interest in a defined 
benefit plan described in section 401(a) (Plan X). Plan X has never 
provided for employee contributions. A has no section 72 (f) investment 
in Plan X. A does not have any interest in any other qualified employer 
plan or individual retirement plan. The alternate valuation date in 
section 2032 does not apply. A did not elect to have the special 
grandfather rule apply. A's interest in Plan X is in the form of a 
qualified joint and survivor annuity. The value of the remaining 
payments under the joint and survivor annuity as of A's date of death 
(determined under D-5) is $2,000,000.
    (b) Because A is age 70 and 9 months of A's date of death, A's life 
expectancy as of A's date of death is calculated using age 70 (A's 
attained age in whole years on A's date of death). The factor from Table 
A of Sec. 20.2031-7(f) used to determine the present value of a single 
life annuity for an individual age 70 is 6.0522. The greater of $150,000 
or $112,500 indexed for 199X is 150,000. The present value of the 
hypothetical single life annuity is $907,830 ($150,000x6.0522)
    (c) The amount of A's excess accumulation is $1,092,170, determined 
as follows: $2,000,000 (value of A's interest in Plan X) minus $907,830 
(value of hypothetical single life annuity contract) equals $1,092,170.
    (d) The increase in the estate tax under section 4981A(d) is 
$163,825 (15 percent of $1,092,170).

[[Page 355]]

    Example 2. (a) The facts are the same as in Example 1, except that 
A's interest in Plan X consists of the following:
    (1) $2,000,000, value of employer-provided portion of a qualified 
joint and survivor annuity determined as of A's date of death using the 
interest and mortality assumptions in Sec. 20.2031-7.
    (2) $200,000, proceeds of a term life insurance contract (no cash 
surrender value before death).
    (3) $100,000. amount (employer-provided portion) payable to A's 
former spouse pursuant to a QDRO.
    (4) $100,000, amount of A's investment in Plan X.
    (b) The value of A's interest in Plan X for purposes of calculating 
A's excess accumulation is still $2,000,000. The proceeds of the term 
life insurance contract, the amount payable under the QDRO, and the 
amount of A's investment in Plan X are excluded from such value.
    Example 3. (a) The facts are the same as in Example 1, except that A 
elected the special grandfather rule. A's initial grandfather amount was 
$1,100,000. As of A's date of death, A had received $500,000 in 
distributions that were treated as a return of A's grandfather amount. 
Thus, A's unused grandfather amount is $600,000 ($1,100,000-$500,000). 
In 199X, assume that $112,500 indexed is still $112,500.
    (b) A's excess retirement accumulation is determined as follows: 
$2,000,000 minus the greater of (1) $600,000 or (2) the present value of 
a period certain annuity of $112,500 a year for 16 years. The present 
value of a single life annuity of $112,500 a year for an individual age 
70 is determined as follows: $112,500 x 6.0522=$680,827.25. $680,827.25 
is greater than $600,000. Thus the amount of the excess retirement 
accumulation is $1,319,173 ($2,000,000 minus $680,827).
    (c) The additional estate tax under section 4981A(d) is $197,875 (15 
percent of $1,319,173).
    Example 4. (a) The facts are the same as in Example 3 except that, 
as of A's date of death, A received $90,000 in distributions that were 
treated as a return of A's grandfather amount. Thus, A's unused 
grandfather amount is $1,010,000 ($1,100,000-$90,000).
    (b) A's excess retirement accumulation is determined as follows: 
$2,000,000 minus the greater of (1) ($1,010,000 (A's unused grandfather 
amount) or (2) 680,827.25 (the present value of a single life annuity of 
$112,500 a year for an individual age 70). A's unused grandfather amount 
is greater than the present value of the hypothetical life annuity. 
Thus, the amount of the excess retirement accumulation is $990,000 
($2,000,000-$1,010,000).
    (c) The additional estate tax under section 4981A(d) is $148,500 (15 
percent of $990,000).

    d-10: Q. if a surviving spouse rolls over a distribution from a 
qualified retirement plan or an individual retirement plan of the 
decedent to an individual retirement plan (IRA) established in the 
spouse's own name, is any distribution in a calendar year from the IRA 
receiving such rollover included in determining the spouse's excess 
distribution or excess accumulation in such calendar year?
    A. (a) General rule. If a surviving spouse rolls over a distribution 
from a qualified retirement plan or an individual retirement plan of the 
decedent to an individual retirement plan (IRA) established in the 
spouse's own name with the rollover contribution and no other 
contributions or transfers are made to the IRA receiving the rollover 
contribution, distributions from such IRA will be excluded in 
determining the spouse's excess distributions and the value of the IRA 
will be excluded in determining the spouse's excess accumulation. If the 
surviving spouse rolls over a distribution from a qualified retirement 
plan or IRA of the decedent to an IRA for which the spouse has prior 
contributions or makes additional contributions to the IRA receiving the 
distribution, distributions from the IRA will be included in determining 
the amount of the excess distributions received by the spouse for the 
calendar year of the distribution and the value of the IRA at the 
applicable valuation date will be included in determining the spouse's 
excess accumulation.
    (b) Special rules. The rule in paragraph (a) of this Q&A d-10 also 
applies if a surviving spouse elects to treat an inherited IRA 
(described in section 408(d)(3)(C)(ii)) as the spouse's own IRA as long 
as the surviving spouse makes no further contributions to such IRA.
    (c) Other beneficiaries. Rules similar to the rules in paragraphs 
(a) and (b) shall apply to an individual who elected to treat an IRA as 
subject to the distribution requirements of section 408(a)(6), prior to 
amendment by section 521(b) of TRA '84, under Sec. 1.408-2(b)(7)(ii) of 
the Income Tax Regulations.
    d-11. Q. To what estates does the excise tax under section 4981A(d) 
apply?

[[Page 356]]

    A. The excise tax under section 4981A(d) applies to estates of 
decedents dying after December 31, 1986.
    d-12: Q. Is the aggregate interest reduced by distributions 
described in paragraph (b)(1) of Q&A c-6 of this section (distributions 
prior to January 1, 1988, made on account of certain terminations of a 
qualified employer plan) which are made after the individual's death.
    A. Yes, the value of the individual's aggregate interest determined 
under Q&A d-5 of this section is reduced by distributions described in 
paragraph (b)(1) of Q&A c-6 of this section which are made after the 
individual's death.

[T.D. 8165, 52 FR 46750, Dec. 10, 1987; 53 FR 18975, May 26, 1988]