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 a nonqualified deferred annuity (NQDA) with a $100,000 deposit, and the NQDA is now worth $75,000.  Would it be better to surrender the contract and claim a tax loss, or do a Section 1035 exchange to a new contract?

Answer: It depends.

An annuity loss may be tax deductible when the contract is surrendered by the taxpayer.  However, the IRS has taken the position that the loss deduction is available only to taxpayers who itemize deductions, and that the deduction is a miscellaneous expense.  Miscellaneous expenses may only be deducted to the extent that all expenses exceed 2% of the taxpayer’s adjusted gross income.  Not every taxpayer can benefit from the loss deduction, and even those that do may be unable to get a complete write-off.

If the taxpayer takes the deduction and re-deposits the $75,000 surrender proceeds into a new NQDA, the taxpayer’s basis in the contract will be $75,000.

If the client does a Section 1035 exchange, no gain or loss can be recognized on the transaction.  The $100,000 basis will be carried over to the new annuity.  If the client holds the new NQDA until it’s worth $100,000 and cashes out, the entire distribution will be income tax free.

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