HAR § 18-235-7-03 — Upon retirement on January 1, 1993, Ms

Bicoy moves to Hawaii and the plan distributes 12 shares of ABC Co. common stock to her. At the time the 12 shares are distributed in 1993, the stock is worth $100 a share, for a total distribution of $1,200. The exclusion ratio is the employer contribution of $6,000 divided by the sum of $6,000 (the employer contribution), the pretax employee contribution of $4,000, and previously taxed contribution of zero in this example. Thus the exclusion ratio is $6,000 / $10,000 or 60 per cent. Hence, $720 is excluded in 1993 under section 235-7(a)(3), HRS, and the remaining $480 is included in 1993 gross income because Ms. Bicoy has no previously taxed contribution. Ms. Bicoy’s basis in the 12 shares of ABC Co. common stock distributed to her would be $480 but for this section. Her basis in the stock is increased by $720, to $1,200. In 1994, the plan distributes to Ms. Bicoy 12 additional shares of ABC Co. common stock, which are then worth $1,500. In 1994, 60 per cent of $1,500, or $900, is excluded under section 235-7(a)(3), HRS, and the remaining $600 is included in her 1994 gross income. The basis of the second 12 shares of ABC Co. common stock in the hands of Ms. Bicoy is increased by $900, to $1,500. The basis of her first 12 shares remains $1,200, and any dividends paid on any shares after distribution to Ms. Bicoy are fully taxable to her. (6) In order to be entitled to the exclusion under section 235-7(a)(3), HRS, the taxpayer bears the burden of proof in establishing the amount of previously taxed contribution and employer contribution. However, where the amount of employer contribution is not determinable the following alternative method may be used: (A) Compute the present discounted value of the payments being made to the employee, as of the payment starting date. The employee’s life expectancy shall be determined under paragraph (3). The interest rate used shall be the rate paid on tax refunds as specified in section 231-23, HRS (8 per cent since January 1, 1968). (B) Determine the future value of all amounts included in previously taxed contribution and pretax employee contribution, as of the payment starting date, using the following assumptions: (i) The interest rate shall be the rate paid on tax refunds as specified in section 231- 23, HRS. (ii) The amounts were paid at the time of contribution. Amounts that are contributed by an employer but are later included in the employee’s gross income shall be considered paid at the time they are included in income. (iii) In computing the interest, the compounding interval shall be the most frequent interval between contributions, but shall not be longer than one year. (C) Subtract the total of the amounts in (B) from the amount in (A). (D) The ratio of (C) to (A) shall be used as the exclusion ratio. Example 4: Under the terms of a qualified defined benefit plan Mr. Corpuz, a male employee aged 66, is entitled to receive $500 a month for the rest of his life beginning on his retirement date of January 1, 1994. He is unable to determine how much his employer contributed, but he contributed $150 a month in pretax income for the past 120 months. Mr. Corpuz has no previously taxed contribution in the plan. Assuming that Mr. Corpuz uses the method of Treas. Reg. §1.72-5, calculation of the excluded amount is as follows. (A) The expected return multiple in Table V of Treas. Reg. §1.72-9 corresponding to Mr. Corpuz’ age is 19.2. Thus, Mr. Corpuz is expected to live 19.2 years, or 12 x 19.2 = 230.4 months. The present value of $500 a month for 230.4 months, discounted at 8 per cent a year, is $58,774. (B) The value of the pretax employee contributions is the future value, as of the annuity starting date, of $150 a month for 120 months at 8 per cent a year, or $27,442. There was no previously taxed contribution. (C) The employer contribution is assumed to be $58,774 - $27,442 = $31,333. (D) The exclusion ratio is $31,333 / $58,774 = 53.3 per cent. Thus 53.3 per cent of every $500 payment, or $267 a month, is considered to be a pension excludable under section 235-7(a)(3), HRS. Example 5: Upon retirement, Mrs. Doo, age 65, begins receiving retirement benefits in the form of a joint and 50 per cent survivor annuity to be paid for the joint lives of Mrs. Doo and her spouse, age 59. Mrs. Doo’s annuity starting date is January 1, 1988. Mrs. Doo is unable to determine how much her employer contributed, but she contributed $50 with each semimonthly paycheck for the past 20 years, totaling $24,000. Her company’s §18-235-7-03 retirement plan does not accept pretax employee contributions. Mrs. Doo was paid twice a month. Mrs. Doo will receive a retirement benefit of $1,000 a month, and her spouse will receive a survivor benefit of $500 a month upon Mrs. Doo’s death. (A) Assume Mrs. Doo uses the method in Internal Revenue Service Notice 88-118, 1988-2 C.B. 450. Under that method, the set number of monthly payments for a distributee who is age 65 is 240. That figure also applies to a survivor annuity. The present value of $1,000 a month for 240 months, discounted at 8 per cent a year, is $119,554. (B) The value of the previously taxed contributions is the future value, as of the annuity starting date, of $50 twice a month for 480 semimonthly periods at 8 per cent a year, or $59,098. The pretax employee contribution is zero. (C) The employer contribution is assumed to be $119,554 -$ 59,098 = $60,456. (D) The exclusion ratio is $60,456 / $119,554 = 50.6 per cent. Thus 50.6 per cent of every $1,000 payment, or $506 a month, is considered to be a pension excludable under section 235-7(a)(3), HRS. When Mrs. Doo dies, 50.6 per cent of every $500 payment to her spouse, or $253 a month, is considered a pension excludable under section 235-7(a)(3), HRS, regardless of how long her spouse lives. In addition, $100 ($24,000 / 240 payments) of each payment to either Mrs. Doo or her spouse is excluded from gross income as a return of capital, under federal rules, until 240 payments have been made to either Mrs. Doo or her spouse. (7) If the exclusion of section 101(b) (with respect to employees’ death benefits), IRC, applies, an additional computation shall be made to prevent double exclusion. (A) If an annuity is paid by reason of the death of an employee, the amount of the section 101(b) exclusion is applicable only to forfeitable amounts under section 101(b)(2)(B), IRC, and thus is allocable solely to the employer’s contribution. The section 101(b) exclusion shall be prorated over the expected return of the annuity, and the prorated amount shall be subtracted from the amount otherwise excludable as a pension. (B) If the section 101(b) exclusion applies to a lump sum, the section 101(b) exclusion shall be allocated among all amounts other than previously taxed contribution, and the amount of the section 101(b) exclusion allocable to the employer contribution shall be subtracted from the amount otherwise excludable as a pension. Example 6: Under the terms of an exempt employee’s pension trust, a beneficiary of an employee who dies before reaching retirement age is entitled to receive $1,200 a year for 10 years. Under the terms of the trust, no other benefits are paid to any other beneficiary or to the estate of the deceased employee. Mr. Esaki, an employee, died in January, 1992, before reaching retirement age, and his beneficiary, his daughter Chelsea, receives $1,200 in 1992. As of the date of his death, Mr. Esaki had $4,000 of previously taxed contribution, and his employer had contributed $6,000. If Mr. Esaki had quit in January, 1992, he would have received $5,000 from the trust. Assume that Chelsea is entitled to a death benefit exclusion of $5,000 under section 101(b), IRC. As in Example 1, the exclusion ratio is 60 per cent. Thus, of the $1,200 Chelsea received in 1992, 60 per cent, or $720, would be excluded as a pension absent the section 101(b) exclusion. However, the section 101(b) exclusion amount allocable to 1992, namely $5,000 / 10 years = $500, is subtracted. The remaining $220 is the amount excluded under section 235-7(a)(3), HRS. Under applicable IRC principles (section 101(b)(2)(D), IRC, relating to annuities other than joint and survivor annuities), the $5,000 is treated as an additional contribution of previously taxed income. Because $900 a year ($4,000 + $5,000, divided by 10 years) is excluded as a return of capital, an additional $900 is excluded in 1992. The remaining amount, $1,200 - $220 - $900 = $80, is included in gross income. Example 7: The facts are the same as in Example 6, except that the beneficiary of an employee who dies before reaching retirement age is entitled to receive $12,000 payable in a lump sum. Thus, Chelsea receives $12,000 in 1992. As in Example 6, the exclusion ratio is 60 per cent. Thus, $7,200 is allocable to the employer contribution and would be excluded under section 235-7(a)(3), HRS, but for section 101(b), IRC. Under this paragraph, the $5,000 exclusion applies to all amounts other than the previously taxed contribution of $4,000, which total $12,000 -$ 4,000, or $8,000. §18-235-7-04 to