From a Reader:

Subject: Your Blog, Friday Aug. 31, Anniuities cashed in

Since when is annuity income anything other than ordinary income under IRC Sec. 72 ? If there is capital gains treatment it's a new one to me. The typical deal on taking a lump sum from a deferred annuity is that the amount received net of any surrender charge less the amount invested in the contract is ordinary income shown on 1040 line 16b. 

My Reply:

If the surrender of the annuity were reported on a 1099-R, you would be correct.

However, there were more assumptions contained in my analysis of the situation than I had time to explicitly spell out. My main one was that this was not a deferred comp retirement account that was being cashed in, but an investment vehicle sold by an insurance company that would have produced ordinary annuity income during its life.

When it was sold back to the insurance company, that would be treated as the sale of a capital asset, much like the sale of a stock or bond that also produces ordinary taxable dividend or interest income during its holding period.

I have actually had several real life cases of this kind of transaction with clients over the years.  Reporting those sales (redemptions) on Schedule D never once created a problem with IRS; so this is more than just a theory on my part.

This is why it is so important for the taxpayer to have a tax professional review the actual transactions and the underlying documents to know with more certainty how something should be reported. 

I hope this better clarifies my answer to that reader.

Thanks for writing.

Kerry Kerstetter

Labels: CapGains

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 9/11/2007 12:07:00 PM Send this post: