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Taxation Of Employee Annuities  
Section 403(b) of the Internal Revenue Code

 
Section 403.
(b)      Taxability Of Beneficiary Under Annuity Purchased By Section 501(c)(3) Organization Or Public School
(1)      General Rule  
If--  
(A)      an annuity contract is purchased--  
(i)      for an employee by an employer described in Section 501(c)(3) which is exempt from tax under Section 501(a), or  
   
(ii)      for an employee (other than an employee described in clause (i)), who performs services for an educational organization described in Section 170(b)(1) (A)(ii), by an employer which is a State, a political subdivision of a State, or an agency or instrumentality of any one or more of the foregoing,  
   
(B)      such annuity contract is not subject to Subsection (a),  
   
(C)      the employee's rights under the contract are nonforfeitable, except for failure to pay future premiums,  
   
(D)      except in the case of a contract purchased by a church, such contract is purchased under a plan which meets the nondiscrimination requirements of Paragraph (12), and  
   
(E)      in the case of a contract purchased under a salary reduction agreement, the contract meets the requirements of Section 401(a)(30), then amounts contributed by such employer for such annuity contract on or after such rights become nonforfeitable shall be excluded from the gross income of the employee for the taxable year to the extent that the aggregate of such amounts does not exceed the exclusion allowance for such taxable year. The amount actually distributed to any distributee under such contract shall be taxable to the distributee (in the year in which so distributed) under Section 72 (relating to annuities). For purposes of applying the rules of this Subsection to amounts contributed by an employer for a taxable year, amounts transferred to a contract described in this Paragraph by reason of a rollover contribution described in Paragraph (8) of this Subsection or (iii) shall not be considered contributed by such employer.  
   
(2)      Exclusion Allowance  
(A)      In General  
For purposes of this Subsection, the exclusion allowance for any employee for the taxable year is an amount equal to the excess, if any, of--  
(i)      the amount determined by multiplying 20 percent of his includible compensation by the number of years of service, over  
   
(ii)      the aggregate of the amounts contributed by the employer for annuity contracts and excludible from the gross income of the employee for any prior taxable year.  
   
(B)      Election To Have Allowance Determined Under Section 415 Rules  
In the case of an employee who makes an election under Section 415(c)(4)(D) to have the provisions of Section (C) (relating to special rule for Section 403(b) contracts purchased by educational institutions, hospitals, home health service agencies, and certain churches, etc.) apply, the exclusion allowance for any such employee for the taxable year is the amount which could be contributed (under Section 415 without regard to Section 415(c)(8)) by his employer under a plan described in Section 403(a) if the annuity contract for the benefit of such employee were treated as a defined contribution plan maintained by the employer.  
   
(C)      Number Of Years Of Service For Duly Ordained, Commissioned, Or Licensed Ministers Or Lay Employees  
For purposes of this Subsection and Section 415(c)(4)(A)--  
(i) all years of service by--  
(I)      a duly ordained, commissioned, or licensed minister of a church, or  
   
(II)      a lay person, as an employee of a church, a convention or association of churches, including an organization described in Section 414(e)(3)(B)(ii), shall be considered as years of service for 1 employer, and  
   
(ii)      all amounts contributed for annuity contracts by each such church (or convention or association of churches) or such organization during such years for such minister or lay person shall be considered to have been contributed by 1 employer. For purposes of the preceding sentence, the terms "church" and "convention or association of churches" have the same meaning as when used in Section 414(e).  
   
(D)      Alternative Exclusion Allowance  
(i)      In General  
In the case of any individual described in Subparagraph (C), the amount determined under Subparagraph (A) shall not be less than the lesser of--  
(I)      $3,000, or  
   
(II)      the includible compensation of such individual.  
   
(ii)      Subparagraph Not To Apply To Individuals With Adjusted Gross Income Over $17,000  
This Subparagraph shall not apply with respect to any taxable year to any individual whose adjusted gross income for such taxable year (determined separately and without regard to any community property laws) exceeds $17,000.  
   
(iii)      Special Rule For Foreign Missionaries  
In the case of an individual described in Subparagraph (C)(i) performing services outside the United States, there shall be included as includible compensation for any year under clause (i)(II) any amount contributed during such year by a church (or convention or association of churches) for an annuity contract with respect to such individual.  
   
(3)      Includible Compensation  
For purposes of this Subsection, the term "includible compensation" means, in the case of any employee, the amount of compensation which is received from the employer described in Paragraph (1)(A), and which is includible in gross income (computed without regard to Section 911) for the most recent period (ending not later than the close of the taxable year) which under Paragraph (4) may be counted as one year of service. Such term does not include any amount contributed by the employer for any annuity contract to which this Subsection applies.  
   
(4)      Years Of Service  
In determining the number of years of service for purposes of this Subsection, there shall be included--  
(A)      one year for each full year during which the individual was a full-time employee of the organization purchasing the annuity for him, and  
   
(B)      a fraction of a year (determined in accordance with regulations prescribed by the Secretary) for each full year during which such individual was a part-time employee of such organization and for each part of a year during which such individual was a full-time or part-time employee of such organization.  
   
In no case shall the number of years of service be less than one.  
   
(5)      Application To More Than One Annuity Contract  
If for any taxable year of the employee this Subsection applies to 2 or more annuity contracts purchased by the employer, such contracts shall be treated as one contract.  
   
(6)      Forfeitable Rights Which Become Nonforfeitable  
For purposes of this Subsection and Section 72(f) (relating to special rules for computing employees' contributions to annuity contracts), if rights of the employee under an annuity contract described in subparagraphs (A) and (B) of Paragraph (1) change from forfeitable to nonforfeitable rights, then the amount (determined without regard to this Subsection) includible in gross income by reason of such change shall be treated as an amount contributed by the employer for such annuity contract as of the time such rights become nonforfeitable.  
   
(7)      Custodial Accounts For Regulated Investment Company Stock  
(A)      Amounts Paid Treated As Contributions  
For purposes of this Title, amounts paid by an employer described in Paragraph (1)(A) to a custodial account which satisfies the requirements of Section 401(f)(2) shall be treated as amounts contributed by him for an annuity contract for his employee if--  
(i)      the amounts are to be invested in regulated investment company stock to be held in that custodial account, and  
   
(ii)      under the custodial account no such amounts may be paid or made available to any distributee before the employee dies, attains age 59-1/2, separates from service, becomes disabled (within the meaning of Section 72(m)(7)), or in the case of contributions made pursuant to a salary reduction agreement (within the meaning of Section 3121(a)(1)(D)), encounters financial hardship.  
   
(B)      Account Treated As Plan  
For purposes of this Title, a custodial account which satisfies the requirements of Section 401(f)(2) shall be treated as an organization described in Section 401(a) solely for purposes of subchapter F and subtitle F with respect to amounts received by it (and income from investment thereof).  
   
(C)      Regulated Investment Company  
For purposes of this Paragraph, the term "regulated investment company" means a domestic corporation which is a regulated investment company within the meaning of Section 851(a).  
   
(8)      Rollover Amounts  
(A)      General Rule  
If--  
(i)      any portion of the balance to the credit of an employee in an annuity contract described in Paragraph (1) is paid to him in an eligible rollover distribution (within the meaning of Section 402(c)(4)), 4  
   
(ii)      the employee transfers any portion of the property he receives in such distribution to an individual retirement plan or to an annuity contract described in Paragraph (1), and  
   
(iii)      in the case of a distribution of property other than money, the property so transferred consists of the property distributed, then such distribution (to the extent so transferred) shall not be includible in gross income for the taxable year in which paid.  
   
(B)      Certain Rules Made Applicable. --  
Rules similar to the rules of paragraphs (2) through (7) of Section 402(c) shall apply for purposes of Subparagraph (A). 5  
   
(9)      Retirement Income Accounts Provided By Churches, Etc.  
(A)      Amounts Paid Treated As Contributions  
For purposes of this Title--  
(i)      a retirement income account shall be treated as an annuity contract described in this Subsection, and  
   
(ii)      amounts paid by an employer described in Paragraph (1)(A) to a retirement income account shall be treated as amounts contributed by the employer for an annuity contract for the employee on whose behalf such account is maintained.  
   
(B)      Retirement Income Account  
For purposes of this Paragraph, the term "retirement income account" means a defined contribution program established or maintained by a church, a convention or association of churches, including an organization described in Section 414(e)(3)(A), to provide benefits under Section 403(b) for an employee described in Paragraph (1) or his beneficiaries.  
   
(10)      Distribution Requirements  
Under regulations prescribed by the Secretary, this Subsection shall not apply to any annuity contract (or to any custodial account described in Paragraph (7) or retirement income account described in Paragraph (9)) unless requirements similar to the requirements of Section 401(a)(9) and 401(a)(31) 6 are met (and requirements similar to the incidental death benefit requirements of Section 401(a) are met) with respect to such annuity contract (or custodial account or retirement income account). Any amount transferred in a direct trustee-to-trustee transfer in accordance with Section 401(a)(31) shall not be includible in gross income for the taxable year of the transfer. 7  
   
(11)      Requirement That Distributions Not Begin Before Age 59-1/2, Separation From Service, Death, Or Disability  
This Subsection shall not apply to any annuity contract unless under such contract distributions attributable to contributions made pursuant to a salary reduction agreement (within the meaning of Section 402(g)(3)(C)) may be paid only--  
(A)      when the employee attains age 59-1/2, separates from service, dies, or becomes disabled (within the meaning of Section 72(m)(7)), or  
   
(B)      in the case of hardship. Such contract may not provide for the distribution of any income attributable to such contributions in the case of hardship.  
(12)      Nondiscrimination Requirements.  
(A)      In General  
For purposes of Paragraph (1)(D), a plan meets the nondiscrimination requirements of this Paragraph if--  
(i)      with respect to contributions not made pursuant to a salary reduction agreement, such plan meets the requirements of paragraphs (4), (5), (17), and (26) of Section 401(a), Section 401(m), and Section 410(b) in the same manner as if such plan were described in Section 401(a), and  
   
(ii)      all employees of the organization may elect to have the employer make contributions of more than $200 pursuant to a salary reduction agreement if any employee of the organization may elect to have the organization make contributions for such contracts pursuant to such agreement.  
For pur  
(B)      Church  
For purposes of Paragraph (1)(D), the term "church" has the meaning given to such term by Section 3121(w)(3)(A). Such term shall include any qualified church-controlled organization (as defined in Section 3121(w)(3)(B)).  
 
(c)      Taxability Of Beneficiary Under Nonqualified Annuities Or Under Annuities Purchased By Exempt Organizations.
Premiums paid by an employer for an annuity contract which is not subject to Subsection (a) shall be included in the gross income of the employee in accordance with Section 83 (relating to property transferred in connection with performance of services), except that the value of such contract shall be substituted for the fair market value of the property for purposes of applying such Section. The preceding sentence shall not apply to that portion of the premiums paid which is excluded from gross income under Subsection (b). In the case of any portion of any contract which is attributable to premiums to which this Subsection applies, the amount actually paid or made available under such contract to any beneficiary which is attributable to such premiums shall be taxable to the beneficiary (in the year in which so paid or made available) under Section 72 (relating to annuities).  
 
(Aug. 16, 1954, ch. 736, 68A Stat. 137; Sept. 2, 1958, Pub. L. 85-866, Title I, Section 23(a)-(c), 72 Stat. 1620-1622; Oct. 4, 1961, Pub. L. 87-370, Section 3(a), 75 Stat. 801; Oct. 10, 1962, Pub. L. 87-792, Section 4(d), 76 Stat. 825; Feb. 26, 1964, Pub. L. 88-272, Title II, Section 232(e)(4)-(6), 78 Stat. 111; Dec. 30, 1969, Pub. L. 91-172, Title III, Section 321(b)(2), Title V, Section 515(a)(2), 83 Stat. 591, 644; Sept. 2, 1974, Pub. L. 93-406, Title II, Section 1022(e), 2002(g)(6), 2004(c)(4), 2005(b)(2), 88 Stat. 940, 969, 986, 991; Apr. 15, 1976, Pub. L. 94-267, Section 1(b), 90 Stat. 366; Oct. 4, 1976, Pub. L. 94-455, Title XIV, Section 1402(b)(1)(D), (2), Title XV, Section 1504(a), Title XIX, Section 1901(a)(58), (b)(8)(A), 1906(b)(13)(A), 90 Stat. 1731, 1732, 1738, 1774, 1794, 1834; Oct. 14, 1978, Pub. L. 95-458, Section 4(b), 92 Stat. 1259; Nov. 6, 1978, Pub. L. 95-600, Title I, Section 154(a), 156(a), (b), 157(g)(2), 92 Stat. 2801, 2802, 2808; Apr. 1, 1980, Pub. L. 96-222, Title I, Section 101(a)(12), (13)(C), 94 Stat. 204; Aug. 13, 1981, Pub. L. 97-34, Title III, Section 311(b)(3)(B), 95 Stat. 280; Sept. 3, 1982, Pub. L. 97-248, Title II, Section 251(a), (b), (c)(3), 96 Stat. 529-531; Jan. 12, 1983, Pub. L. 97-448, Title I, Section 103(c)(8)(B), 96 Stat. 2377; Apr. 20, 1983, Pub. L. 98-21, Title I, Section 122(c)(4), 97 Stat. 87; July 18, 1984, Pub. L. 98-369, div. A, Title IV, Section 491(d)(12), Title V, Section 521(c), 522(a)(2), (3), (d)(9)-(11), Title X, Section 1001(b)(4), 98 Stat. 849, 867, 869-871, 1011; Oct. 22, 1986, Pub. L. 99-514, Title XI, Section 1120(a), (b), 1122(b)(1)(B), (d), 1123(c), Title XVIII, Section 1852(a)(3)(A), (B), (5)(B), (b)(10), 100 Stat. 2463, 2466, 2469, 2474, 2865, 2867; Nov. 10, 1988, Pub. L. 100-647, Title I, Section 1011(c)(7)(B), (12), (m)(1), (2), Title VI, Section 6052(a)(1), 102 Stat. 3458, 3459, 3471, 3696; Nov. 5, 1990, Pub. L. 101-508, Title XI, Section 11701(k), 104 Stat. 1388-513; Aug. 20, 1996, Pub. L. 104-188, Title I, Section 1450, 1704(t)(69), 110 Stat. 1755.)

Last updated: 03-04

 
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