Annuity loss and AMT

[taxxcpa]

A client took a full distribution of about $ 180000 from an annuity which had cost him about $ 325000.
In researching this I read an article that suggested the conservative approach would be to report it as a 'miscellaneous deduction' subject to the 2%. However this would cause about $ 70000 alternative minimum tax.

The same article suggested a more aggressive approach: show the loss on Form 4797 which would make my client's tax zero.

Since there was a 1099-R issued, the income will have to be reported, so the $ 180000 will have to be both income and additional cost to make the net result come out to the equivalent of $ 325000-180000. So it will show up as income on line 16 and again as the sale on Form 4797.

Should I take the 'aggressive' approach or take the 'safer' approach and let the client pay the AMT?

Has anyone had this problem? And how did you handle it?

[taxmom34]

all i know about annuities would fit in a thimble, (my sister rolled over her 401K into an annuity) so this post is confusing me more than ever. are annuities under the same rules as IRA'S and 401K, in that gains and losses within the plan are not reportable. and since this client took a full distribution and it is on a 1099R is that not the end of it?

[taxxcpa]

Annuity vs 401K or IRA

all i know about annuities would fit in a thimble, (my sister rolled over her 401K into an annuity) so this post is confusing me more than ever. are annuities under the same rules as IRA'S and 401K, in that gains and losses within the plan are not reportable. and since this client took a full distribution and it is on a 1099R is that not the end of it?

I thought the same thing before I read this:

http://www.fool.com/personal-finance/taxes/2006/08/11/deducting-annuity-losses.aspx

[Burke]

A client took a full distribution of about $ 180000 from an annuity which had cost him about $ 325000.In researching this I read an article that suggested the conservative approach would be to report it as a 'miscellaneous deduction' subject to the 2%. However this would cause about $ 70000 alternative minimum tax.The same article suggested a more aggressive approach: show the loss on Form 4797 which would make my client's tax zero.Since there was a 1099-R issued, the income will have to be reported, so the $ 180000 will have to be both income and additional cost to make the net result come out to the equivalent of $ 325000-180000. So it will show up as income on line 16 and again as the sale on Form 4797.Should I take the 'aggressive' approach or take the 'safer' approach and let the client pay the AMT?Has anyone had this problem? And how did you handle it?

Losses from a tax-deferred annuity (non-IRA) are treated as you said on Sche A subj to 2%. What justification did the article use for claiming on 4797 which would be business property? This asset is classified as 1035 not 1231. And an annuity would be classified as a capital asset, not non-capital asset.

[Zee]

Another article (almost the same) suggests the following, but doesn't suggest using the Form 4797:

"Now here's the more gutsy approach: Instead of listing your annuity loss as a "Miscellaneous Deduction," some tax experts think it is more appropriate for it to be listed under "Other Gains/Losses" (Line #14 on Form 1040 for 2001). An IRS Revenue Ruling that dates back to 1961 seems to support this approach.* In fact, some tax advisors are going so far as to make a copy of this decision and attaching it to their client's tax returns".

Both reference Revenue Ruling 61-201, 1961-2, CB46. I can't find the ruling on the internet...can anyone else?

[S T]

Prior Thread

Yes, we had this discussion before

here is the prior thread http://www.thetaxbook.com/forums/sho...LIFIED+ANNUITY and http://www.thetaxbook.com/forums/sho...d+annuity+loss

So maybe these will assist you.

Sandy

[taxxcpa]

My conclusion

Thanks for all the input. I will let the client decide and will include a Form 8275 citing Rev Rulings 61-201 and 72-193 as the basis if he wants to take it as an ordinary loss.

There are sure to be thousands of people with large losses on variable annuities, mutual funds, ETFs and probably a lot of people will pull out of 401Ks and IRAs as well.

As to the basis, the client obtained a statement from the annuity to support the loss.

[Burke]

all i know about annuities would fit in a thimble, (my sister rolled over her 401K into an annuity) so this post is confusing me more than ever. are annuities under the same rules as IRA'S and 401K, in that gains and losses within the plan are not reportable. and since this client took a full distribution and it is on a 1099R is that not the end of it?

No. You are confusing non-qualified annuities with traditional IRA's and 401K's (which are accounts with pretax contributions and any withdrawal is subsequently included in taxable income.) A "non-qualified" tax-deferred annuity contract is purchased through an insurance company with after-tax dollars, so there is a basis. And they were around long before IRA's came into being. Those dollars were previously taxed, so if the TP withdraws his funds and his proceeds are less than his original basis, he has a deductible loss, disregarding any surrender charges from the insurance company. The confusing part arises in that an annuity may be purchased inside an IRA, in which case there is no tax basis. IRA stands for Individual Retirement ACCOUNT not annuity. So your sister may have rolled over her 401k into a "qualified" annuity contract, and it still retains the same tax character as the original 401k was, which is pre-tax. The distinction is between "non-qualified" (after tax basis) and "qualified" (pre-tax basis.) Sometimes you will see these terms on statements, but sometimes you won't. And often these annuity contracts are purchased through brokerages, but if you look closer it is underwritten by an insurance company and there is a contract issued to the buyer.

[New York Enrolled Agent]

Both reference Revenue Ruling 61-201, 1961-2, CB46. I can't find the ruling on the internet...can anyone else?

Rev. Rul. 61-201, 1961-2 CB 46 -- IRC Sec. 165 (CAPS added for emphasis)

Full Text:
Advice has been requested with respect to the method of computing the basis of a single premium refund annuity contract for the purpose of determining the amount of loss sustained by the original purchaser upon his surrender of the annuity contract for a cash consideration.

The taxpayer purchased a single premium refund annuity policy for 25x dollars. In 1956, he surrendered the policy for a cash consideration of 10x dollars. The annuity payments received during prior years totaled 15x dollars of which 7x dollars were excluded from gross income under the law applicable at the time of receipt.

I.T. 3567, C.B. 1942-2, 105, holds, insofar as pertinent here, that the amount of a loss allowable upon the surrender of a single premium refund annuity contract, is the cost less the aggregate of the amount received on its surrender plus all other amounts received under the contract by the annuitant. Under I.T. 3567 no distinction is made between annuity payments which were included in the annuitant's gross income when received and annuity payments which were excluded from the annuitant's gross income.

Section 1.72-11(d)(1) of the Income Tax Regulations promulgated under section 72 of the Internal Revenue Code of 1954, provides, in part, as follows:

Any amount received upon the surrender, redemption or maturity of a contract to which section 72 applies, which is not received as an annuity under the rules of section 1.72-2(b), shall be included in the gross income of the recipient to the extent that it, when added to amounts previously received under the contract and which were excludable from the gross income of the recipient under the law applicable at the time of receipt, exceeds the aggregate of premiums or other consideration paid. ***

It is clear that the contract under consideration is one to which section 72 of the Code applies and that the 10x dollars received by the taxpayer, upon surrender of the contract, was “an amount not received as an annuity” under section 72(e) of the Code. It is likewise clear that, where the transaction results in a loss, the same treatment should be afforded the taxpayer as is afforded where the transaction results in a gain. Further, the amount of 7x dollars excluded from gross income in the instant case merely represents a recovery of “basis” (investment) for which adjustment is required under section 1016(a)(1) of the Code, which provides, as far as here pertinent, that proper adjustment in respect of property shall in all cases be made for receipts properly chargeable to capital account.

Accordingly, in determining the amount of loss sustained in the instant case by the original purchaser upon his surrender of a single premium refund annuity contract for a cash consideration, the basis of the contract is its cost (25x dollars) less the amounts previously received under the contract which were properly excludable from the gross income of the recipient under the law applicable at the time of receipt (7x dollars). The excess of the basis thus determined (18x dollars) over the amount received upon surrender of the contract (10x dollars) constitutes an ORDINARY LOSS (8x dollars).

I.T. 3567, supra, is modified to remove therefrom the implication that the entire amounts of the annuity payments received by the annuitant are deducted from his cost of the annuity contract in computing the amount of loss sustained upon its surrender.<Page 48>

Nothing in this ruling should be construed as permitting a loss deduction on the surrender of any contract other than a refund annuity.

[Burke]

Thanks for that. I was just getting ready to look it up. However, it only addresses the computation of loss/gain and confirms that a loss can be deducted. It says nothing about treating it as an ord loss on 4797 or elsewhere. Since the IRS instructions specifically state an annuity loss is a Sche A deduction subject to 2% exclusion, I would be extremely reluctant to take it otherwise absent a CCA or court ruling to that effect. I want to look at 72-193 which Sandy mentioned.