Internal Revenue Service
Revenue Ruling 71-153
26 CFR 1.401-8: Custodial accounts.
(Also Sections 72, 402, 503; 1.72-1, 1.402(b)-1, 1.503(d)-1.)
Rev. Rul. 71-153
Advice has been requested concerning the effect on qualification and the Federal income tax consequences to participants when a previously qualified custodial account fails to meet the requirements of section 401 of the Internal Revenue Code of 1954.
An employer established a custodial account, in lieu of a trust, as part of his qualified pension plan covering self-employed individuals. During the first two plan years, the custodial account met the requirements of section 401 of the Code and was treated as a qualified trust. During the third plan year, the custodial account failed to meet the requirements of section 401 of the Code.
Section 401(f) of the Code provides that a custodial account shall be treated as a qualified trust under section 401 if it would, but for the fact that it is not a trust, qualify under that section and if it meets certain additional requirements.
Section 1.401-8(d) of the Income Tax Regulations provides that, if a custodial account that has qualified under section 401 of the Code fails to qualify under such section for any taxable year, such account will not thereafter be treated as a separate legal person, and the funds in such account shall be treated as made available within the meaning of section 402(a)(1) to the employees for whom they are held. Section 402(a)(1) of the Code provides that distributions thereunder are taxable under section 72.
Accordingly, it is held that the custodial account in this case may not regain its qualified status in any subsequent year. It is further held that the funds in the account are treated as made available within the meaning of section 402(a)(1) of the Code and are, therefore, taxable to the participants under section 72 of the Code in the year in which the account fails to qualify.
The treatment in the case of a previously qualified and exempt employees' trust that fails to qualify or loses its exemption in a given taxable year is different from that in the case of a custodial account. In the case of the trust, taxability of participants is governed by section 402(b) of the Code as amended by the Tax Reform Act of 1969. Furthermore, the trust may regain its exempt status in a subsequent year. See section 503(c) of the Code (section 503(d) prior to the Tax Reform Act of 1969) relating to reestablishment of exemption of an employees' trust that has entered into a prohibited transaction.
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