Category: Individuals Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Taxpayer is receiving an annuity. In 1996, he received $26,649. His total investment in the contract is $50,174. You have treated these amounts under the normal annuity rules (IRC Section 72(b)) whereby a portion of each amount received is allocated to income and a portion to recovery of initial investment. The nontaxable portion of each payment is the amount of each payment that bears the same ratio to the total payment as the original contribution bears to the total expected payments under the contract. The taxpayer has been told two things by his colleagues. A) It is possible to recover his entire investment in the contract prior to recognizing any taxable income from the annuity payments. B) Five-year forward averaging is possible. Neither of these two things is correct. Your treatment is correct. For annuities that started before July 2, 1986, a taxpayer could exclude his entire investment prior to recognition of any income from the annuity if the entire investment was expected to be recovered within three years. This was called the cost-recovery method. The cost-recovery method was repealed by the 86 Tax Act. You are also correct that five-year forward averaging only is available for lump-sum distributions, which this clearly is not. A lump-sum distribution, as the name implies, must be paid out in one lump sum. See IRC Section 402(d)(4)(A). As stated above, your treatment of this annuity under the general exclusion ratio rules of Section 72(b) is the proper treatment. |
