[Federal Register Volume 79, Number 91 (Monday, May 12, 2014)]
[Rules and Regulations]
[Pages 26838-26843]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-10849]
[[Page 26838]]
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9665]
RIN 1545-BG12
Tax Treatment of Qualified Retirement Plan Payment of Accident or
Health Insurance Premiums
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations clarifying the rules
regarding the tax treatment of payments by qualified retirement plans
for accident or health insurance. The final regulations set forth the
general rule under section 402(a) that amounts held in a qualified plan
that are used to pay accident or health insurance premiums are taxable
distributions unless described in certain statutory exceptions. The
final regulations do not extend this result to arrangements under which
amounts are used to pay premiums for disability insurance that replaces
retirement plan contributions in the event of a participant's
disability. These regulations affect sponsors, administrators,
participants, and beneficiaries of qualified retirement plans.
DATES: Effective Date: These regulations are effective on May 12, 2014.
Applicability Date: These regulations generally apply for taxable
years that begin on or after January 1, 2015. However, taxpayers may
elect to apply the regulations to earlier taxable years. See the
``Effective/Applicability Dates'' section in this preamble for
additional information regarding the applicability of these
regulations.
FOR FURTHER INFORMATION CONTACT: Michael P. Brewer or Lauson C. Green
at (202) 317-6700 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to 26 CFR part 1 under section
402(a) of the Internal Revenue Code (Code), as well as conforming
amendments under sections 72, 105, 106, 401, 402(c), 403(a), and
403(b).
Section 104(a)(3) provides, in general, that gross income does not
include amounts received through accident or health insurance (or
through an arrangement having the effect of accident or health
insurance) for personal injuries or sickness. This exclusion does not
apply to amounts attributable to (and not in excess of) deductions
allowed under section 213 for any prior taxable year, or to other
amounts received by an employee to the extent the amounts either are
attributable to contributions by the employer that were not includible
in the gross income of the employee or are paid by the employer.
Section 105(a) provides that, except as otherwise provided, amounts
received by an employee through accident or health insurance for
personal injuries or sickness are included in gross income to the
extent the amounts (1) are attributable to contributions by the
employer that were not includible in the gross income of the employee
or (2) are paid by the employer.
Section 105(b) generally provides that, except in the case of
amounts attributable to deductions allowed under section 213 for any
prior taxable year, gross income does not include amounts referred to
in section 105(a) if the amounts are paid, directly or indirectly, to
the taxpayer to reimburse the taxpayer for expenses incurred by the
taxpayer for the medical care of the taxpayer and his or her spouse or
dependents (as defined in section 152, determined without regard to
paragraphs (b)(1), (b)(2), and (d)(1)(B) thereof) and any child (as
defined in section 152(f)(1)) of the taxpayer who as of the end of the
taxable year has not attained age 27.
Section 106(a) provides that, except as otherwise provided, the
gross income of an employee does not include employer-provided coverage
under an accident or health plan. Section 1.106-1 of the Income Tax
Regulations provides that the gross income of an employee does not
include contributions that the employer makes to ``an accident or
health plan for compensation (through insurance or otherwise) to the
employee for personal injuries or sickness incurred'' by the employee
or the employee's spouse or dependents.
For purposes of the Code, section 7702B(a) treats a qualified long-
term care insurance contract as an accident and health insurance
contract, and a plan of an employer providing coverage under a
qualified long-term care insurance contract as an accident and health
plan with respect to that coverage.
Section 213 generally allows a deduction for expenses paid during
the taxable year, not compensated for by insurance or otherwise, for
medical care of the taxpayer and the taxpayer's spouse and dependents,
to the extent that the expenses exceed 10 percent of the taxpayer's
adjusted gross income.\1\ Section 213(d)(1) provides that the term
``medical care'' includes amounts paid for insurance covering medical
care (including eligible long-term care premiums with respect to
qualified long-term care insurance contracts).
---------------------------------------------------------------------------
\1\ The 7.5 percent threshold applicable before 2013 continues
to apply through 2016 for individuals age 65 and older. See section
213(f).
---------------------------------------------------------------------------
Section 401(a) sets forth requirements for a trust forming part of
a pension, profit-sharing, or stock bonus plan to be qualified under
section 401(a).
Section 401(h) provides that a pension or annuity plan may provide
for the payment of benefits for sickness, accident, hospitalization,
and medical expenses of retired employees, their spouses and their
dependents only if certain enumerated conditions are met. Those
conditions include: (1) The aggregate actual contributions for medical
benefits (when added to actual contributions for life insurance
protection under the plan) may not exceed 25 percent of the total
actual contributions to the plan (other than contributions to fund past
service credits) after the date on which the account is established;
(2) a separate account must be established and maintained for such
benefits; (3) the employer's contributions to the separate account must
be reasonable and ascertainable; (4) it must be impossible, at any time
prior to the satisfaction of all liabilities under the plan to provide
such benefits, for any part of the corpus or income of such separate
account to be (within the taxable year or thereafter) used for, or
diverted to, any purpose other than the providing of such benefits; (5)
any amount remaining after satisfaction of all liabilities must, under
the terms of the plan, be returned to the employer; and (6) special
limitations for the accounts of key employees (as defined in section
401(h)) must be satisfied.
Section 402(a) provides, in general, that any amount actually
distributed by a qualified plan is taxable under section 72 in the
taxable year in which distributed.
Section 72(a) provides that, except as otherwise provided, gross
income includes any amount received as an annuity (whether for a period
certain or during one or more lives) under an annuity, endowment, or
life insurance contract. Sections 72(d) and (e), which apply to any
amount received as an annuity and any amount not received as an
annuity, respectively, provide rules for determining the portion of any
distribution that is not includable in
[[Page 26839]]
gross income as a recovery of a participant's investment in the
contract (generally the amount of the unrecovered after-tax employee
contributions) under a qualified employer retirement plan.
Section 402(l) provides a limited exclusion from gross income for
distributions from an eligible retirement plan used to pay health or
long-term care insurance premiums of an eligible retired public safety
officer to the extent that the aggregate amount of the distributions
for the taxable year is not in excess of the qualified health insurance
premiums of the retired public safety officer and his or her spouse or
dependents. The total amount excluded from gross income pursuant to
section 402(l) is limited to $3,000.
Section 1.72-15 provides rules relating to the tax treatment of
amounts paid from an employer-established plan to which section 72
applies and which provides for distributions of accident or health
benefits. With respect to benefits that are attributable to employer
contributions, Sec. 1.72-15(d) provides that any amount received as an
accident or health benefit is includible in gross income, except to the
extent excludable from gross income under section 105(b) (relating to
reimbursements of medical care expenses as defined in section
213(d)).\2\ Section 1.72-15(e) provides that the taxability of benefits
that are not accident or health benefits is determined under section 72
without regard to any exclusion under section 104 or 105.
---------------------------------------------------------------------------
\2\ Section 1.72-15(d) also refers to benefits excludible under
section 105(c) (relating to certain payments unrelated to absence
from work) or section 105(d), which was repealed in 1983 (and which
related to certain disability payments).
---------------------------------------------------------------------------
Section 1.401-1(b)(1)(i) provides that a plan is not a pension plan
within the meaning of section 401(a) if it provides for the payment of
benefits not customarily included in a pension plan, such as layoff
benefits or benefits for sickness, accident, hospitalization, or
medical expenses (except for medical benefits described in section
401(h)).
Section 1.401-1(b)(1)(ii) provides that a profit-sharing plan
within the meaning of section 401(a) is primarily a plan of deferred
compensation, but that amounts allocated to the account of a
participant may be used to provide incidental life or accident or
health insurance for the participant and the participant's family.
Section 1.401-1(b)(1)(iii) provides that a stock bonus plan is a plan
established and maintained by the employer to provide benefits similar
to those of a profit-sharing plan.
Rev. Rul. 61-164 (1961-2 CB 99) (see Sec. 601.601(d)(2)(ii)(b))
holds that a profit-sharing plan does not violate the incidental
benefit rule in Sec. 1.401-1(b)(1)(ii) merely because, in accordance
with the plan's terms, each participant's account under the plan is
charged with the cost of health insurance for the participant under
group hospitalization insurance for the employer's employees, provided
that the total amount used for life or accident or health insurance for
the employee and the employee's family is incidental. The ruling also
holds that the use of profit-sharing plan funds to pay for medical
insurance for a participant and his or her beneficiary is a
distribution within the meaning of section 402.
Rev. Rul. 73-501 (1973-2 CB 127) (see Sec. 601.601(d)(2)(ii)(b))
applies the incidental benefit rule to the purchase of life insurance
by a profit-sharing plan. The ruling states that ``[u]nder a qualified
profit-sharing plan, the use of trust funds to pay the cost of life,
accident, or health insurance for an employee is a distribution within
the purview of section 402 of the Code.''
Rev. Rul. 2003-62 (2003-1 CB 1034) holds that amounts distributed
from a qualified retirement plan that the distributee elects to have
applied to pay health insurance premiums under a cafeteria plan are
includible in the distributee's gross income. The ruling also holds
that the same conclusion applies if amounts distributed from the plan
are applied directly to reimburse medical care expenses incurred by a
participant.
Rev. Rul. 2005-55 (2005-2 CB 284) holds that a profit-sharing plan
that provides a sub-account that permits distributions only for the
purpose of reimbursing the participant for substantiated medical
expenses imposes conditions on the entitlement of the participant to
amounts held in the sub-account and, as a result of the conditions,
does not meet the nonforfeitability requirements of section 411.
Proposed regulations (REG-148393-06) under section 402(a) (proposed
regulations) were published by the Treasury Department and the IRS in
the Federal Register on August 20, 2007 (72 FR 46421). Corrections to
the proposed regulations were published in Announcement 2007-98 (2007-2
CB 896). The Treasury Department and the IRS received written comments
on the proposed regulations and a public hearing was held on December
6, 2007.
After consideration of the comments received in response to the
proposed regulations, these final regulations generally adopt the
provisions of the proposed regulations with certain modifications as
described under the heading ``Summary of Comments and Explanation of
Provisions.''
Summary of Comments and Explanation of Provisions
General Treatment of Accident or Health Insurance
Consistent with the proposed regulations, the final regulations
clarify that a payment from a qualified plan for an accident or health
insurance premium generally constitutes a distribution under section
402(a) that is taxable to the distributee under section 72 in the
taxable year in which the premium is paid. The taxable amount generally
equals the amount of the premium charged against the participant's
benefits under the plan. If a defined contribution plan pays these
premiums from a current year contribution or forfeiture that has not
been allocated to a participant's account, then the amount of the
premium for each participant will be treated as first being allocated
to the participant and then charged against the participant's benefits
under the plan. Therefore, the payment of an accident or health plan
premium from unallocated contributions or forfeitures also will
constitute a distribution to the participant under section 402(a) that
is taxable under section 72 in the taxable year in which the premium is
paid.
Like the proposed regulations, these regulations provide that a
distribution for the payment of the premiums by a qualified plan
generally is not excluded from gross income under sections 104, 105, or
106. However, the distribution may constitute a payment for medical
care under section 213. Furthermore, to the extent that the payment of
premiums for accident or health insurance has been treated as a
distribution from a qualified plan, amounts received through the
accident or health insurance for personal injuries or sickness are
excludable from gross income under section 104(a)(3) and are not
treated as distributions from the plan.
The general rule that the payment of an accident and health
insurance premium from a qualified plan constitutes a distribution that
is taxable under section 402 does not apply if another statutory
provision provides for a different result. For example, section 402(l)
provides an exclusion from gross income, up to $3,000 annually, for
distributions paid directly to an insurer to purchase accident or
health insurance or qualified long-term care insurance for an eligible
retired public safety officer
[[Page 26840]]
and his or her spouse or dependents. A similar exclusion applies for
medical benefits for retired employees provided from an account
described in section 401(h).
In accordance with these regulations, as with the proposed
regulations, if a payment of a premium for accident or health insurance
is treated as a distribution from the trust, then the insurance
contract would not be treated as an investment under which the
insurer's payments to the trust are treated as a return on that
investment. As a result, payments from such a contract that are made to
the trust (rather than made to the medical service provider or the
participant as reimbursement for covered expenses) are treated as
having been made to the participant and then contributed by the
participant to the plan.
Special Rule for Disability Insurance Coverage
The preamble to the proposed regulations requested comments on
whether there should be limited exceptions to the general rule in the
proposed regulations, including whether there should be an exception
for a provision that has the effect of a waiver of premium in the case
of disability. All of the commenters that addressed the issue of
payment of premiums for disability insurance from a plan recommended an
exception for disability insurance arrangements that replace retirement
plan contributions, describing these arrangements as having the same
effect as a waiver of premiums in the case of disability. For example,
commenters described an employer's general disability program that not
only provides for wage replacement, but also provides for the purchase
of insurance to make payments to a qualified plan in the event of a
participant's disability that are intended to replace the contributions
that would have been made if the participant was not disabled. These
commenters requested that the regulations provide that a participant
not be currently taxable on the premiums paid by the plan for this type
of disability coverage. Similarly, they recommended the participant not
be taxed when payments from the disability insurance contract are
allocated to the participant's account after the participant becomes
disabled. These comments pointed out that the payments would be taxable
when benefits are ultimately distributed from the plan.
The Treasury Department and the IRS agree that the purchase of this
type of disability coverage by a qualified plan is distinguishable from
the purchase of medical insurance by a plan because the functional
purpose of the disability insurance coverage is to replace retirement
contributions to the plan, instead of providing medical benefits
outside of the plan. Accordingly, these final regulations provide an
exception for the payment of disability insurance premiums from a
qualified plan if the insurance contract provides for payment of
benefits to be made to the trust in the event of an employee's
inability to continue employment with the employer due to disability,
provided that the payment of benefits with respect to an employee's
account does not exceed the reasonable expectation of the annual
contributions that would have been made to the plan on the employee's
behalf during the period of disability, reduced by any other
contributions made on the employee's behalf for the period of
disability within the year. For example, under this standard, the
payment of benefits with respect to an employee's account may increase
to reflect reasonably expected future salary increases. To the extent
these conditions are satisfied, the insurance does not constitute a
distribution to which section 402(a) applies and instead will be
treated as any other plan investment. However, if the insurance
contract provides for payment of benefits that exceed the reasonable
expectation of the annual contributions that would have been made to
the plan on the employee's behalf during the period of disability, then
the exception for disability coverage would not apply and all of the
premium payments made to provide the benefits to the employee would be
treated as distributed to the employee under section 402(a) and (as
described in this preamble) benefits from the coverage paid to the plan
would constitute contributions. This limitation on the benefits payable
under a contract is consistent with treating the disability coverage as
a waiver of premium in case of disability, similar to the provision in
Sec. 1.408-3(a) under which a contract is not treated as other than an
individual retirement annuity merely because it provides for waiver of
premium upon disability. Additionally, the limitation means that
benefits provided by the plan in the event of disability generally will
be comparable to the disability benefits provided by a qualified
disability benefit under a defined benefit plan, as described in
section 411(a)(9) and Sec. 1.411(a)-7(c)(3).
Some commenters recommended that the exception for disability
coverage not result in different tax treatment for plan participants
depending upon whether their employer insured or self-insured the
disability benefit. The final regulations only address the situation in
which payment of premiums is made from the plan. The Treasury
Department and the IRS have concluded that, to the extent the insurance
premiums are not paid by the plan or out of contributions to the plan,
the disability insurance contract is not an asset of the plan and the
amounts received by the plan under the disability insurance contract
are not properly treated as a return on a plan investment. Instead, in
such a case, the amounts paid from the insurance contract to the plan
would be treated as contributions to the plan and would be subject to
the general rules that apply to qualified plan contributions, including
section 415(c). Similarly, to the extent the employer self-insures or
makes arrangements to finance the disability coverage other than
through third party insurance, the amounts paid to the plan on account
of disability would be considered a contribution to the plan and would
be subject to the general rules that apply to qualified plan
contributions, including section 415(c). Payments to the plan will not
be properly characterized as a return on a plan investment in any of
these situations.
Conforming Amendments
The regulations contain conforming amendments to the Income Tax
Regulations under sections 72, 105, 106, 401, and 402(c). These
conforming amendments remove obsolete provisions, as well as cite to
the rules in these regulations for determining the tax treatment of the
payment of premiums for accident and health insurance from a qualified
plan.\3\
---------------------------------------------------------------------------
\3\ The regulations do not alter the incidental benefit rule of
Sec. 1.401-1(b)(1)(ii) (which provides that a profit-sharing plan
may provide incidental life or accident or health insurance for the
participant and the participant's family) nor do they alter the tax
treatment of the payment of life insurance. For the tax treatment of
payments for life insurance, see section 72(m)(3) and Sec. 1.72-16.
---------------------------------------------------------------------------
Conforming amendments to the regulations under sections 403(a) and
403(b) also add a cross-reference applying these rules under section
402(a) to sections 403(a) and 403(b) arrangements. As a result, amounts
paid for disability insurance premiums from an annuity or account under
section 403(a) or 403(b) do not constitute distributions (and the
disability insurance contracts are treated as plan investments) if the
requirements applicable to the purchase of disability insurance by
qualified plans are met. As in the case of a plan described in section
401(a), if the plan sponsor of an annuity
[[Page 26841]]
or custodial account under section 403(a) or section 403(b) financed
the disability protection by paying premiums for disability insurance
that provides coverage to protect against a loss of contributions
during a period of disability, then the benefits paid by the disability
insurer would be treated as employer contributions to the annuity or
account. However, if the premiums for the disability insurance were
paid from the annuity or account in accordance with the rules that
apply to qualified plans, then the benefits paid by the disability
insurer will be treated as a return on plan investment.
In addition, the regulations revise the first sentence of Sec.
1.106-1 in order to update the definition of the term ``dependent'' to
reflect section 207 of the Working Families Tax Relief Act of 2004,
Public Law 108-311 (118 Stat. 1166 (2004)) and Notice 2004-79 (2004-2
CB 898) and to reflect the amendment of section 105(b) made by section
1004(d)(1) of the Health Care and Education Reconciliation Act of 2010,
Public Law 111-152 (124 Stat. 1029 (2010)), to include certain children
who have not attained age 27. For periods before the applicability date
of the regulations, taxpayers can rely on the interpretation of this
latter provision set forth in Notice 2010-38 (2010-20 IRB 682).
These regulations also include a cross-reference to section 402(l)
and amend Sec. 1.402(c)-2, Q&A-4, to add distributions of premiums for
accident or health insurance under Sec. 1.402(a)-1(e)(1) to the list
of items that are not eligible rollover distributions.
Effective/Applicability Date
The regulations apply for taxable years beginning on or after
January 1, 2015. No inference should be drawn that the payment of
accident or health premiums from a qualified plan does not constitute a
taxable distribution if made in an earlier taxable year. However,
taxpayers may elect to apply the regulations to earlier taxable years.
Statement of Availability of IRS Documents
The recently issued IRS notices and revenue rulings cited in this
preamble are published in the Internal Revenue Bulletin or Cumulative
Bulletin and are available from the Superintendent of Documents, P.O.
Box 979050, St. Louis, MO 63197-9000, or by visiting the IRS Web site
at http://www.irs.gov.
Special Analyses
It has been determined that these regulations are not a significant
regulatory action as defined in Executive Order 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because these regulations do
not impose a collection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Code, the proposed regulations
preceding these final regulations were submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
impact on small business.
Drafting Information
The principal authors of these regulations are Michael P. Brewer
and Lauson C. Green, Office of Division Counsel/Associate Chief Counsel
(Tax Exempt and Government Entities). However, other personnel from the
IRS and the Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART I--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.72-15 is amended by:
0
1. Revising the last sentence of paragraph (a).
0
2. Revising paragraph (d).
0
3. Removing and reserving paragraph (f).
0
4. Revising paragraphs (h) and (i).
The revisions read as follows:
Sec. 1.72-15 Applicability of section 72 to accident or health plans.
(a) Applicability of section. * * * Paragraphs (d), (h), and (i) of
this section apply for taxable years beginning on or after January 1,
2015.
* * * * *
(d) Accident or health benefits attributable to employer
contributions. Any amounts received as accident or health benefits and
not attributable to contributions of the employee are includible in
gross income except to the extent that the amounts are excludable from
gross income under section 105(b) or (c) and the regulations under
those sections. See Sec. 1.402(a)-1(e) for rules relating to the use
of a qualified plan under section 401(a) to pay premiums for accident
or health insurance.
* * * * *
(h) Medical benefits for retired employees, etc. See Sec.
1.402(a)-1(e)(2) for rules relating to the payment of medical benefits
described in section 401(h) under a qualified pension or annuity plan.
(i) Special rules--(1) In general. For purposes of section 72(b)
and (d) and this section, the taxpayer must maintain such records as
are necessary to substantiate the amount treated as an investment in
the taxpayer's annuity contract.
(2) Delegation to Commissioner. The Commissioner may prescribe a
form and instructions with respect to the taxpayer's past and current
treatment of amounts received under section 72 or 105, and the
taxpayer's computation, or recomputation, of the taxpayer's investment
in his or her annuity contract. This form may be required to be filed
with the taxpayer's returns for years in which the amounts are excluded
under section 72 or 105.
Sec. 1.105-4 [Removed]
0
Par. 3. Section 1.105-4 is removed.
Sec. 1.105-6 [Removed]
0
Par. 4. Section 1.105-6 is removed.
0
Par. 5. Section 1.106-1 is amended by:
0
1. Redesignating the existing text as paragraph (a).
0
2. In newly-designated paragraph (a), revising the first sentence and
adding a sentence at the end of the paragraph.
0
3. Adding paragraph (b).
The revisions and additions read as follows:
Sec. 1.106-1 Contributions by employer to accident and health plans.
(a) The gross income of an employee does not include the
contributions that the employer makes to an accident or health plan for
compensation (through insurance or otherwise) to the employee for
personal injuries or sickness incurred by the employee, the employee's
spouse, the employee's dependents (as defined in section 152 determined
without regard to section 152(b)(1), (b)(2), or (d)(1)(B)), or any
child (as defined in section 152(f)(1)) of the employee who as of the
end of the taxable year has not attained age 27. * * * For the
treatment of the payment of premiums for accident or health insurance
from a qualified trust under section 401(a), see Sec. Sec. 1.72-15 and
1.402(a)-1(e).
(b) Effective/applicability date. The first and last sentences of
paragraph (a)
[[Page 26842]]
of this section apply for taxable years beginning on or after January
1, 2015.
Par. 6. Section 1.401-1 is amended by adding a sentence at the end
of paragraph (b)(1)(ii) to read as follows:
Sec. 1.401-1 Qualified pension, profit-sharing, and stock bonus
plans.
* * * * *
(b) * * *
(1) * * *
(ii) * * * See Sec. Sec. 1.72-15, 1.72-16, and 1.402(a)-1(e) for
rules regarding the tax treatment of incidental life or accident or
health insurance.
* * * * *
Par. 7. Section 1.402(a)-1 is amended by:
0
1. Revising the next to last sentence in paragraph (a)(1)(ii).
0
2. Removing the last sentence in paragraph (a)(1)(ii).
0
3. Adding paragraph (e).
The revision and addition read as follows:
Sec. 1.402(a)-1 Taxability of beneficiary under a trust which meets
the requirements of section 401(a).
(a) * * *
(1) * * *
(ii) * * * Paragraph (e) of this section provides rules relating to
use of a qualified pension, annuity, profit-sharing, or stock bonus
plan to provide accident or health benefits or coverage otherwise
described in sections 104, 105, or 106.
* * * * *
(e) Medical, accident, etc. benefits paid from a qualified pension,
annuity, profit-sharing, or stock bonus plan--(1) Payment of premiums--
(i) General rule. Except as provided in paragraph (e)(1)(iii) of this
section, a payment made from a qualified trust that is a premium for
accident or health insurance (including a qualified long-term care
insurance contract under section 7702B) constitutes a distribution
under section 402(a) to the participant for whose benefit the premium
is charged. The amount of the distribution equals the amount of the
premium charged against the participant's benefits under the plan. If a
defined contribution plan pays these premiums from a current year
contribution or forfeiture that has not been allocated to a
participant's account, then the amount of the premium for each
participant is treated as first being allocated to the participant and
then charged against the participant's benefits under the plan, so that
the amount of the distribution is treated in the same manner as
determined under the preceding sentence. Except as provided in
paragraphs (e)(2) and (e)(3) of this section, a distribution described
in this paragraph (e)(1) is not excludable from gross income.
(ii) Treatment of amounts received through accident or health
insurance. To the extent that the payment of a premium for accident or
health insurance constitutes a distribution under this paragraph
(e)(1), amounts received through accident or health insurance are
neither paid by the employer nor attributable to contributions by the
employer that are excludable from the gross income of the employee.
Accordingly, to the extent the premium for accident or health insurance
constitutes a distribution under this paragraph (e)(1), amounts
received through the accident or health insurance for personal injuries
or sickness are excludable from gross income under section 104(a)(3)
and are not treated as distributions from the plan. If those amounts
are paid to the plan instead of to the employee, those amounts are
treated as having been paid to the employee and then contributed by the
employee to the plan (and must satisfy the qualification requirements
applicable to employee contributions).
(iii) Exception for disability insurance that replaces retirement
contributions. The rules of paragraph (e)(1)(i) of this section do not
apply to the payment made from a qualified trust that is a premium paid
to an insurance company for a contract providing for payment of
benefits to be made to the trust in the event of an employee's
inability to continue employment with the employer due to disability,
provided that the payment of benefits with respect to the employee's
account for each year does not exceed the reasonable expectation of the
annual contributions that would have been made to the plan on the
employee's behalf for the period of disability within that year,
reduced by any other contributions made on the employee's behalf for
the period of disability within that year. The payment of premiums
described in the preceding sentence is not treated as a distribution
under section 402(a), but instead constitutes incidental accident or
health insurance as provided in Sec. 1.401-1(b)(1)(ii). The
Commissioner may issue rules of general applicability in revenue
rulings, notices, or other guidance published in the Internal Revenue
Bulletin further describing the tax treatment of disability coverage
described in this paragraph (e)(1)(iii).
(2) Medical benefits for retired employees provided under an
account described in section 401(h). The payment of medical benefits
under a pension or annuity plan from an account described in section
401(h) is treated in the same manner as a payment of accident or health
benefits attributable to employer contributions, or employer-provided
coverage under an accident or health plan. See Sec. 1.401-14(a) for
the definition of medical benefits described in section 401(h).
Accordingly, amounts applied for the payment of accident or health
benefits, or for the payment of accident or health coverage, from a
section 401(h) account are not includible in the gross income of the
participant on whose behalf such contributions are made to the extent
they are excludible from gross income under section 104, 105, or 106.
(3) Distributions to eligible retired public safety officers. See
section 402(l) (and any guidance issued under section 402(l)) for a
limited exclusion from gross income for distributions used to pay for
certain accident or health premiums (including premiums for qualified
long-term care insurance contracts). This limited exclusion applies to
eligible retired public safety officers, as defined in section
402(l)(4)(B).
(4) Effect of distribution of insurance premiums on plan
qualification. See Sec. 1.401-1(b)(1) for rules concerning the types
and amount of medical coverage and benefits that are permitted to be
provided under a plan that is part of a trust described in section
401(a). For example, Sec. 1.401-1(b)(1)(ii) provides that a profit-
sharing plan is primarily a plan of deferred compensation, but the
amounts allocated to the account of a participant may be used to
provide incidental accident or health insurance for the participant and
the participant's family. See also section 401(k)(2)(B) for certain
restrictions on the distribution of elective contributions.
(5) Applicability to beneficiaries and alternate payees. This
paragraph (e) applies to the payment of premiums charged against the
benefits of a beneficiary or an alternate payee in the same manner as
the payment of premiums charged against the account of a participant.
(6) Examples. The provisions of this paragraph (e) are illustrated
by the following examples:
Example 1. (i) Facts. Employer A sponsors a profit-sharing plan
qualified under section 401(a). The plan provides solely for non-
elective employer profit-sharing contributions. The plan's trustee
enters into a contract with a third-party insurance carrier to
provide health insurance for certain plan participants. The
insurance contract provides for the payment of medical expenses
incurred by those participants. The plan limits the amounts used to
provide medical benefits to comply with the incidental benefit
[[Page 26843]]
rules. The trustee makes monthly payments of $1,000 to pay the
premiums due for Participant P's health insurance and Participant
P's account balance is reduced by $1,000 at the time of each premium
payment. In June 2015, Participant P is admitted to the hospital for
covered medical care, and in July 2015, the health insurer pays the
hospital $5,000 for the medical care provided to Participant P in
June.
(ii) Conclusion. Under paragraph (e)(1) of this section, each of
the trustee's payments of $1,000 constitutes a taxable distribution
under section 402(a) to Participant P on the date of each payment.
The amount of these distributions may constitute payments for
medical care under section 213. The $5,000 payment to the hospital
is excludable from Participant P's gross income under section
104(a)(3) and is not treated as a distribution from the plan.
Example 2. (i) Facts. Employer B sponsors a profit-sharing plan
qualified under section 401(a). The plan provides for elective
contributions described in section 401(k) and matching contributions
as well as non-elective employer profit-sharing contributions. The
plan does not provide that a disabled participant's compensation for
purposes of determining plan contributions includes amounts that the
participant would have received in the absence of the disability,
and accordingly Employer B does not make any contributions to the
plan for the benefit of a disabled employee for the period of
disability. The plan's trustee enters into a contract with a third-
party insurance carrier to provide disability insurance for plan
participants who elect to be covered under the insurance contract.
The insurance contract provides for the payment of an amount to the
trustee on a participant's behalf during the period of the
participant's disability. Amounts to be paid to the trustee from the
insurance contract with respect to a participant are equal to the
sum of the elective, matching, and non-elective employer profit-
sharing contributions that would have been made on the participant's
behalf during the participant's disability (based on the
participant's rate of compensation before becoming disabled) with
the payments to continue for the duration of the disability until
age 65 (or 5 years after the participant became disabled, if later).
Participant Q elects to be covered under the insurance contract, and
the trustee makes the periodic premium payments out of the account
balance of Participant Q. In June 2015, Participant Q becomes
disabled. During the period Participant Q is absent from employment
due to disability, the insurer pays the trust the amount of the
elective contributions and non-elective employer profit-sharing
contributions that would have been made to the trust with respect to
Participant Q had Participant Q not been disabled. The amount of the
premiums for the insurance contract satisfies the limitations on
incidental benefits under Sec. 1.401-1(b)(1)(ii).
(ii) Conclusion. The payment of premiums from the trust is
described in paragraph (e)(1)(iii) of this section. Accordingly,
none of the premium payments under the contract constitute a
distribution under section 402(a) to Participant Q. Further, amounts
paid from the insurance contract to the trust also do not constitute
a distribution to Participant Q. However, when Participant Q's
account balance is distributed from the trust, the distribution will
be subject to taxation in the year of distribution in accordance
with the rules in section 402.
(7) Effective/applicability date. This paragraph (e) applies for
taxable years beginning on or after January 1, 2015.
Par. 8. Section 1.402(c)-2 is amended by redesignating paragraph A-
4(j) as paragraph A-4(k) and adding a new paragraph A-4(j) to read as
follows:
Sec. 1.402(c)-2 Eligible rollover contributions; questions and
answers.
* * * * *
A-4: * * *
(j) Distributions of premiums for accident or health insurance
under Sec. 1.402(a)-1(e)(1)(i). This paragraph A-4(j) applies for
taxable years beginning on or after January 1, 2015.
* * * * *
Par. 9. Section 1.403(a)-1 is amended by revising paragraph (g) to
read as follows:
Sec. 1.403(a)-1 Taxability of beneficiary under a qualified annuity
plan.
* * * * *
(g) The rules of Sec. 1.402(a)-1(e) apply for purposes of
determining the treatment of amounts paid to provide accident and
health insurance benefits.
Par. 10. Section 1.403(b)-6 is amended in paragraph (g) by adding
two sentences at the end of the paragraph to read as follows:
Sec. 1.403(b)-6 Timing of distributions and benefits.
* * * * *
(g) * * * The rules of Sec. 1.402(a)-1(e) apply for purposes of
determining when certain incidental benefits are treated as distributed
and included in gross income. See Sec. Sec. 1.72-15 and 1.72-16.
* * * * *
John Dalrymple,
Deputy Commissioner for Services and Enforcement.
Approved: May 6, 2014.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2014-10849 Filed 5-9-14; 8:45 am]
BILLING CODE 4830-01-P