EIC from Annuity Income?

[Justataxguy]

New client comes by the other day "wondering if I could help him". Seems he was hurt on the job a few years ago, received a worker's compensation settlement and purchased an annuity. Brought me copies of his self (or "buddy") prepared 2011 and 2012 tax returns with the annuity amount in box 7 as wages, which resulted in a healthy EIC claim as he has 3 children. Says he was having trouble getting this years return to come out like the last 2 (or more) years. Letter from the annuity company states "that the type of annuity referenced is a non-qualified annuity, which was funded with after tax dollars. Since the distributions we processed .......... represented a withdrawal of principal and therefore were not taxable to you, an IRS 1099R tax form will not be issued". He does have 10% withheld though for taxes. Page 3-21 in TTB states that annuity income is taxable. Is there some rule other than treating code 3 1099R income as wages for someone under retirement age that would apply in this case?

[Bees Knees]

Annuity income is not earned income for purposes of EIC. Therefore, prior year returns that have him getting EIC for a distribution from an annuity are in error. It is irrelevant where the money came from that was invested in the annuity. Once the money is inside the annuity, it is no longer considered earned income for EIC purposes.

As to a non-qualified annuity, it is true that the principal is after tax money. The taxable portion of a non-qualified annuity distribution represents earnings (investment earnings, not earned income). So if the total distribution represents principal, then none of the distribution is taxable. Only the annuity company can calculate this, so you have to trust what they say is correct.

However, even if it is 100% non-taxable, a distribution from an annuity should be reported on a 1099-R with the taxable portion reported as zero.

[luke]

sounds like

your guy has a problem! Don't think annuity income is "earned" income for EIC purposes (TTB pg11-10). You will have difficulty getting withholding refunded without a form1099?
You should advise client that 2011 and 2012 need to be amended because EIC was claimed improperly (notice I said "advise" client - if client does not wish to amend then I would "cut him loose").
I have very similar problem with client this year and she has yet to "decide" on what to do about 2011-12 returns.

[Burke]

You have apparently received a Form 1099-R with a Code 3? If so, this is unusual in and of itself from a tax-deferred annuity which was purchased by the TP from an insurance company. In another place, you said the company was not issuing a 1099-R. And the other thing I question is the annuity company's claim that they are distributing principal only. IRS rules require insurance companies to apportion distributions between earnings and principal on a tax-deferred annuity. So they should issue a 1099-R, code 7, with gross amount the full amount paid, and the taxable amount as the earnings, if the policy has annuitized. What I suspect is happening here, is some annuities allow a withdrawal of up to 10% of the principal each year. Perhaps the TP is doing this, which would not be considered taxable nor applied to earnings, but a distribution of principal. It definitely is not reported on Line 7 as wages.

Certain retirement benefits from a company for whom the TP worked when paid to a person because of disability, are coded 3 up until their normal retirement age. These do go on Line 7 as wages.

[ddoshan]

I don't quite understand or at least was not aware that one could go out and purchase an annuity themselves after the fact and somehow it is considered some sort of disability annuity. Are you sure the annuity does not have something to do with his previous work or job in which he was injured.

[Burke]

Doesn't sound like it. OP said he got money from a worker's compensation claim and then purchased an annuity. What I don't understand is how he could have "10% withheld as taxes" and not get a 1099R (which he said the insurance company told him it wasn't going to issue.) Doesn't make sense.

[Justataxguy]

There is no 1099 in this case. I was inquiring to see if this could be something like a 1099 with a code 3. I don't know how it was prepared in the past to get what he got. I'm thinking I'll cut him loose as suggested.

[JohnH]

I'm beginning to think he isn't being honest with you. He's withholding information. Looks like he's truing to feed you just enough info to try and get a desired outcome, but he doesn't know how to bring that about. Or maybe he's honest but doesn't comprehend what he has done.

In any event, you don't have all the info you need and what you do have is adding up to a big mess. You're probably going to have to spend a lot of time to sort it out, and at the end of the process tell him he owes back a large amount of wrongfully claimed EIC. Boy is he going to be happy. Once he gets in trouble over the EIC claims, he probably won't be able to play you for helping him and he may even secretly blame you for his being in that predicament. Best to cut him loose, IMO.

[Burke]

Yes, I agree. He may not have a clue that the prior returns were done incorrectly. But the prior preparer should have known better than to put it on Line 7 as wages when there were no 1099R's to show how the benefits were paid or what they represented.