Advanced Underwriting Consultants

Question of the Day – February 10

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client bought two nonqualified deferred annuities (NQDAs) in 2001 from the same life insurance company.  She paid $5,000 for the first annuity, and $20,000 for the second one.  She surrendered the first NQDA for its $8,000 surrender value in 2011. She received a Form 1099 from the insurance company showing that all $8,000 she received is taxable.  That seems wrong—only the gain portion of $3,000 should be taxable.  Do you agree?

Answer: No.  Unfortunately for your client, there is a special rule built into the tax code that aggregates two NQDAs purchased in the same year for the purpose of figuring gain.

Here’s an excerpt from Code Section 72(e)(12):

(12) Anti-abuse rules

(A) In general

For purposes of determining the amount includible in gross income under this subsection –

(i) all modified endowment contracts issued by the same

company to the same policyholder during any calendar year

shall be treated as 1 modified endowment contract, and

(ii) all annuity contracts issued by the same company to

the same policyholder during any calendar year shall be

treated as 1 annuity contract.

Therefore, in this case, the gain in both NQDAs purchased by the client from the same company in 2001 would be aggregated.  If the gain for both contracts added up to be $8,000 or more, the entire $8,000 received from the surrender of the one contract would be taxable.

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