IRS Revenue Ruling 71-153

SDI Commentary on IRS Revenue Ruling 71-153:  401(k) plans (including Solo 401k's) can be structured in one of two manners:  As a "custodial" plan or as a "trust" plan.  Revenue Ruling 71-153 addresses the substantial difference in ramifications concerning "custodial" versus "trust" 401(k) plans in the event the plan fails to continue to be qualified under Section 401.

 

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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