Serves to increase the cash value of the annuity no

This preview shows page 19 - 20 out of 21 pages.

serves to increase the cash value of the annuity. No income is recognized by the annuitant at the time the cash value of the annuity increases because the taxpayer has not actually received any income. The income is not constructively received because, generally, the taxpayer must cancel the policy to receive the increase in value (the increase in value is subject to substantial restrictions). The tax accounting problem associated with receiving payments under an annuity contract is one of apportioning the amounts received between recovery of capital and income. The annuitant can exclude from income (as a recovery of capital) the proportion of each payment that the investment in the contract bears to the expected return under the contract. The exclusion amount is calculated as follows: (Investment/ Expected Return) x Annuity Payment = Exclusion. The expected return is the annual amount to be paid to the annuitant multiplied by the number of years the payments will be received. The payment period may be fixed (a term certain) or for the life of one or more individuals. When payments are for life, the taxpayer generally must use the annuity table published by the IRS to determine the expected return. The expected return is calculated by multiplying the appropriate multiple (life expectancy) by the annual payment. The exclusion ratio (investment / expected return) applies until the annuitant has recovered his or her investment in the contract. Once the investment is recovered, the entire amount of subsequent payments is taxable. If the annuitant dies before recovering the investment, the unrecovered cost (adjusted basis) is deductible in the year the payments cease (usually the year of death). The taxpayer's expected return is $300 x 12 x 20.8 = $74,880. The exclusion percentage is . 667735, rounded to 66.77%, ($50,000 investment/$74,880). The expected return is $2,403.72 (66.77% x $3,600 annual payment). The $2,403.72 is a nontaxable return of capital, and $1,196.28 ($3,600 - $2,403.72), rounded to $1,196 is included in gross income.
Tax Drill - Annuities A taxpayer, age 64, purchases an annuity from an insurance company for $50,000. She is to receive $300 per month for life. Her life expectancy 20.8 years from the annuity starting date. Assuming that she receives $3,600 this year, what is the exclusion percentage and how much is included in her gross income? Round the exclusion percentage to two decimal places. Round the final answer for the income to the nearest dollar.

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture