26 U.S.C. § 402 — Taxability of beneficiary of employees’ trust

(a) Taxability of beneficiary of exempt trust Money actually paid out to someone from a tax-exempt employees' trust (a "section 401(a)" trust exempt under section 501(a)) is taxed to that person in the year they get it, under the annuity rules in section 72. (b) Taxability of beneficiary of nonexempt trust (1) Contributions: If the trust isn't tax-exempt for a year, the employer's contributions that year count as income to the employee right away, following the property-transfer rules of section 83 — except the value of the employee's interest in the trust is used instead of the property's fair market value. (2) Distributions: Money actually paid out from a nonexempt trust is taxed to the person who gets it, in the year paid, under section 72's annuity rules. But income distributed before the "annuity starting date" is fully taxed, without the partial shelter that section 72(e)(5) would normally give. (3) Grantor trusts: A beneficiary of this kind of trust is not treated as owning any part of it under the grantor-trust rules. (4) Failure to meet requirements of section 410(b): (A) If a trust lost its exemption because the plan failed the coverage tests in section 401(a)(26) or 410(b), a highly compensated employee (as defined in section 414(q)) must instead include in income the vested value of their accrued benefit (not counting their own investment in the contract) as of the end of the trust's tax year. (B) This harsher rule does not apply to an employee who was not highly compensated during that year or any earlier period whose service counted under the plan. (C) "Highly compensated employee" takes its meaning from section 414(q). (c) Rules applicable to rollovers from exempt trusts (1) Exclusion from income: If part of an employee's balance in a qualified trust is paid out as an "eligible rollover distribution," and the person transfers it to an eligible retirement plan (transferring the same property, if property rather than money was distributed), the transferred amount is not taxed in the year paid. (2) Maximum amount that may be rolled over: Normally only the taxable part of the distribution can be rolled over tax-free. Two exceptions let the whole distribution move: a direct trustee-to-trustee transfer to a qualified trust or 403(b) annuity that separately tracks taxable and non-taxable amounts, or a transfer to certain governmental plans or IRAs listed in (c)(8)(B)(i)-(ii). In either exception, the transfer is treated as moving the taxable part first. (3) Time limit on transfers: (A) The transfer must generally happen within 60 days of receiving the distribution. (B) The Secretary can waive that 60-day deadline when enforcing it would be unfair — for example, because of a casualty, disaster, or other event beyond the person's control. (C) A "qualified plan loan offset amount" — an offset caused solely by the plan terminating or by the employee's job ending while a plan loan is unpaid — can instead be rolled over any time up to the extended tax-return due date for the year of the offset. This extension only applies if the loan was exempt from the usual loan-tax rules under section 72(p)(2). "Plan loan offset amount" means the cut to the employee's accrued benefit made to repay a loan; "qualified employer plan" takes its meaning from section 72(p)(4). (4) Eligible rollover distribution: This means essentially any part of an employee's qualified-trust balance that is distributed, except: (A) payments that are part of a series of substantially equal payments made at least yearly over the employee's life or life expectancy (or joint life expectancy with a beneficiary), or over a fixed period of 10 years or more; (B) required minimum distributions under section 401(a)(9); and (C) hardship distributions. A special rule for 2020: if a distribution only counted as an eligible rollover distribution because the minimum-distribution rules were suspended that year, it is not treated as an eligible rollover distribution for purposes of section 401(a)(31), 3405(c), or subsection (f). (5) A transfer to one of the plans listed in (8)(B)(i)-(ii) that excludes an amount from income under paragraph (1) is treated as a rollover contribution under section 408(d)(3). (6) Sales of distributed property: (A) Rolling over the proceeds from selling distributed property counts as rolling over the property itself. (B) Any gain in value between distribution and sale is treated as part of the distributed property. (C) If part of a distribution is property and only part is rolled over, the taxable and rolled-over portions are split on a pro-rata basis unless the taxpayer chooses otherwise by the tax-return deadline (with extensions); once made, that choice can't be changed. (D) No gain or loss is recognized on such a sale, to the extent the proceeds are rolled over. (7) Special rule for frozen deposits: (A) The 60-day rollover clock stops running while the money is a "frozen deposit," and never ends sooner than 10 days after it stops being frozen. (B) A "frozen deposit" is money that can't be withdrawn because a bank is insolvent or bankrupt, or because of a related state restriction — but only counts if it was actually frozen on at least one day during the normal 60-day window. (8) Definitions: (A) "Qualified trust" means a tax-exempt trust described in section 401(a). (B) "Eligible retirement plan" means an IRA, an individual retirement annuity (other than an endowment contract), a qualified trust, a section 403(a) annuity plan, certain governmental section 457(b) plans, or a section 403(b) annuity contract; money from a designated Roth account can only roll into another designated Roth account or a Roth IRA. (9) If a distribution is paid to the employee's spouse after the employee's death, all these rollover rules apply to the spouse as if the spouse were the employee. (10) A governmental section 457(b) plan can't accept rollovers from other kinds of retirement plans unless it agrees to track those amounts separately. (11) Distributions to an inherited IRA for a nonspouse beneficiary: (A) If a deceased employee's qualified-trust balance is transferred directly, trustee-to-trustee, into an IRA set up for a non-spouse "designated beneficiary" (as defined in section 401(a)(9)(E)), the transfer counts as an eligible rollover distribution, the IRA is treated as an inherited IRA, and the required-minimum-distribution rules of section 401(a)(9)(B) (except clause (iv)) apply to it. (B) A trust set up for one or more designated beneficiaries can, under Secretary-prescribed rules, be treated the same as a designated beneficiary. (12) For an inadvertent benefit overpayment rolled into an eligible retirement plan: the part the plan isn't trying to recover is treated as a normal eligible rollover distribution; the part the plan is trying to recover can be sent back to the plan and is treated as an eligible rollover distribution the recipient made, with both plans treated as permitting the transfer. (13) Recontributions of withdrawals for home purchases: (A) Someone who received a "qualified distribution" can, during the "applicable period," repay up to that amount into an eligible retirement plan they're eligible to roll into; repayment rules mirror the disaster-repayment rules in section 72(t)(11)(C)(ii)-(iii). (B) A "qualified distribution" is one described in specific hardship/first-time-homebuyer provisions, that was meant to buy or build a home in a federally declared disaster area but wasn't used for that because of the disaster, and that was received in the window from 180 days before the disaster's "incident period" to 30 days after it ended. (C) "Qualified disaster," "qualified disaster area," "incident period," and "applicable period" borrow their meanings from section 72(t)(11) and 72(t)(8)(F). (d) Taxability of beneficiary of certain foreign situs trusts A pension, profit-sharing, or stock-bonus trust that would otherwise qualify for the section 501(a) tax exemption, except that it was created outside the United States, is still treated as an exempt trust for purposes of subsections (a), (b), and (c). (e) Other rules applicable to exempt trusts (1) Alternate payees: (A) A spouse or former spouse who is an "alternate payee" under a qualified domestic relations order (a QDRO, defined in section 414(p)) is treated as the distributee for subsection (a) and section 72 purposes. (B) The rollover rules in subsection (c) apply to that alternate payee's distribution the same way they would to the employee. (2) Distributions by the United States to nonresident aliens: the taxable amount of a federal pension paid to a nonresident alien is capped, using the ratio of (A) the employee's basic pay that was taxable as U.S.-source income to (B) all of the employee's basic pay for that service. For civil-service retirees, "basic pay" has the meaning given in 5 U.S.C. § 8331(3). (3) Cash or deferred arrangements: Employer contributions to a 401(k)-type plan or a 403(b) salary-reduction plan aren't treated as paid to the employee, or as the employee's own contribution, merely because the employee could have chosen cash instead. (4) Net unrealized appreciation: (A) For a distribution that isn't a lump sum, the taxable amount excludes any increase in value of employer stock traceable to the employee's own (non-deductible) contributions; this doesn't apply to a rollover distribution under subsection (c). (B) For a lump-sum distribution that includes employer stock, the built-in gain on that stock ("net unrealized appreciation") isn't taxed when distributed, though a taxpayer can elect out of this on their tax return. (C) The Secretary's regulations govern how to calculate the unrealized appreciation and resulting basis adjustments. (D) "Lump-sum distribution" means a full payout, within one tax year, of an employee's trust balance, triggered by death, reaching age 59½, leaving the job, or becoming disabled (as defined in section 72(m)(7)), from a qualifying trust or a section 403(a) plan; the "leaving the job" trigger applies only to regular employees, and the "disability" trigger only to certain self-employed people; payouts split across multiple trusts still count as one distribution; the balance excludes accumulated deductible employee contributions. For counting the balance, all trusts in one plan, and all of an employer's pension (likewise profit-sharing, likewise stock-bonus) plans, are grouped together; non-qualified trusts and non-qualifying annuity contracts are ignored; community property laws are disregarded; this treatment doesn't apply to amounts covered by the penalty in section 72(m)(5)(A); the balance excludes amounts owed to a QDRO alternate payee and amounts moved into a cost-of-living arrangement under a defined benefit plan; and a QDRO payout to a spouse or ex-spouse counts as a lump-sum distribution if the employee's own payout would have. (E) "Securities" means only stock, bonds, or debentures with interest coupons or in registered form; "securities of the employer corporation" includes securities of its parent or subsidiary corporations, as defined in section 424(e) and (f). (5) [Repealed.] (6) A direct trustee-to-trustee transfer made under section 401(a)(31) is not included in income for the year of the transfer. (f) Written explanation to recipients of distributions eligible for rollover treatment (1) Before making an eligible rollover distribution, the plan administrator must give the recipient a written explanation covering: how the recipient can have the distribution sent directly to an eligible retirement plan, and that automatic direct transfer applies to certain distributions under section 401(a)(31)(B); that tax will be withheld if the money isn't transferred directly; that the distribution won't be taxed if rolled over within 60 days; subsections (d) and (e) of this section, if they apply; and that the receiving plan's distributions may carry different restrictions and tax consequences than the original plan's. (2) "Eligible rollover distribution" has the meaning used in subsection (c) and in the parallel provisions for sections 403(a), 403(b)(8)(A), and 457(e)(16)(A), and also includes certain designated-beneficiary distributions described in subsection (c)(11) or its parallel provisions; "eligible retirement plan" has the meaning given in (c)(8)(B). (g) Limitation on exclusion for elective deferrals (1) (A) An individual's elective deferrals for a year are taxable to the extent they exceed the "applicable dollar amount," except for the part of the excess made up of designated Roth contributions, which stays excluded. (B) The applicable dollar amount is $15,000. (2) If deferrals are taxed under paragraph (1) (or would be but for the Roth exception), the individual can, by March 1 of the next year, tell each plan how much excess to attribute to it, and each plan can then distribute that amount plus earnings to the individual by the following April 15, notwithstanding any other law. (B) Unless the Secretary says otherwise, a distributed excess deferral still counts as an employer contribution when testing the plan under section 401(k)(3)(A)(ii). (C) The returned excess itself isn't taxed again, but any earnings on it are taxed in the year distributed, with no 10% early-withdrawal penalty under section 72(t). (D) A partial distribution of the excess and its earnings is treated as coming proportionally from both. (3) "Elective deferrals" means the sum of certain untaxed 401(k) employer contributions, certain untaxed SEP salary-reduction contributions under subsection (h)(1)(B), 403(b) salary-reduction annuity contributions, and SIMPLE-IRA elective contributions under section 408(p)(2)(A)(i) — except a 403(b) contribution resulting from a one-time irrevocable election made at initial eligibility (or a similar arrangement under regulations) doesn't count. (4) Starting with tax years after 2006, the Secretary adjusts the $15,000 figure for cost of living the same way as under section 415(d), using the calendar quarter starting July 1, 2005 as the base period, rounding increases down to the nearest $500. (5) Community property laws are disregarded here. (6) An amount taxed under this subsection that stays in the plan isn't treated as the employee's "investment in the contract" for section 72 purposes. (7) For a "qualified employee" (15+ years of service, as defined by section 403(b)) of a "qualified organization" (an educational, hospital, home-health, health/welfare, or church organization, using pre-2001 definitions from section 415(c)(4)), the normal deferral limit is increased by the smallest of $3,000; $15,000 minus amounts already excluded under this catch-up rule in prior years; or $5,000 times years of service minus employer contributions already made for the employee in prior years. (8) A matching contribution for a self-employed person (as described in section 401(m)(4)(A)) isn't treated as an "elective employer contribution," except as section 401(k)(3)(D)(ii) provides. (h) Special rules for simplified employee pensions (SEPs) (1) Employer contributions to a SEP generally aren't treated as paid to, or contributed by, the employee — even under a salary-reduction SEP where the employee can choose whether the employer contributes — except that a SEP contribution going into a Roth IRA isn't excludable from income. (2) A year's SEP contribution that exceeds the lesser of 25% of the employee's compensation from that employer (figured without the SEP contribution) or the dollar limit under section 415(c)(1)(A) (reduced for highly compensated employees) is treated as paid to, and contributed by, the employee. (3) Distributions from a SEP-IRA are taxed under the ordinary IRA rules of section 408(d) (or 408A(d) for a Roth IRA). (i) Treatment of self-employed individuals "Employee" in this section includes a self-employed person as defined in section 401(c)(1)(B), except as subsection (e)(4)(D)(i) provides otherwise; that person's "employer" is whoever counts as their employer under section 401(c)(4). (j) Effect of disposition of stock by plan on net unrealized appreciation (1) When a covered transaction happens, it's ignored when figuring "net unrealized appreciation" under subsection (e)(4). (2) Covered transactions are the plan trustee swapping employer stock for other employer stock, or selling employer stock and using the proceeds to buy more employer stock within 90 days (or a longer Secretary-set period) — except this doesn't apply to any employee who received a cash distribution between the sale and the repurchase. (k) Treatment of simple retirement accounts The rules in subsection (h)(1) and (h)(3) for SEP contributions and distributions apply the same way to SIMPLE retirement accounts under section 408(p). (l) Distributions from governmental plans for health and long-term care insurance (1) An "eligible retired public safety officer" who makes the election described in paragraph (6) can exclude from income distributions from an eligible governmental retirement plan, up to what they paid that year for "qualified health insurance premiums." (2) The most that can be excluded this way in a year is $3,000. (3) (A) Only amounts that would be taxable anyway count toward this exclusion. (B) A special ordering rule under section 72 treats all the officer's eligible plans from that employer as one contract when figuring the taxable amount. (4) "Eligible retirement plan" here means a governmental plan (as defined in section 414(d)) of the type listed in (c)(8)(B)(iii)-(vi). "Eligible retired public safety officer" means someone who left service as a public safety officer, due to disability or normal retirement age, with the employer running the plan. "Public safety officer" borrows its meaning from the Omnibus Crime Control and Safe Streets Act of 1968, as it read just before the 2013 defense authorization act. "Qualified health insurance premiums" means premiums for the officer, spouse, and dependents under an accident/health plan or qualified long-term-care insurance contract. (5) (A) The premium can be paid directly to the insurer from the distribution, or to the employee — if paid to the employee, the employee must attest on their tax return that the distribution didn't exceed what they paid in premiums. (B) All the employer's eligible plans are treated as a single plan. (6) The election is made by the employee after leaving service, to have plan amounts paid out to cover qualified health insurance premiums; making this election, or a distribution under it, doesn't violate section 401 qualification rules or count as a prohibited transaction under section 503(b). (7) This exclusion isn't also counted under the medical expense deduction in section 213. (8) This exclusion isn't also counted under the self-employed health insurance deduction in section 162(l).