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Year-End Tax Planning: Are Variable Annuity Losses Deductible?

Year-End Tax Planning: Are Variable Annuity Losses Deductible?

After months of loss in his adjustable annuity, your customer comes to you requesting whether it’s time to move his money to greener pastures. How do you proceed? You might not be in the business of giving tax advice, but the move will be seriously affected by the tax implications of the loss. Can the loss to be deducted?

And if so, how much will of the loss can be deducted, and is it a capital or ordinary loss? The final question which should one think of is if the discussion is an offering opportunity in disguise. The good news is that a loss in an adjustable annuity is deductible-although there’s no solid answer on the mechanics of deducting losing.

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The first requirement of deducting losing is common to all or any loss: you’ll need to understand the loss before the loss can be recognized for tax purposes. The basic principle is the same as for stock deficits; if the worthiness of your Microsoft stock drops 15%, you don’t reach deduct losing unless the stock is sold by you and realize losing.

The same is true for a adjustable annuity. 60,000, you can’t deduct the loss until you understand it. How are losses in a VA realized? Like a stock, your customer must “sell” the annuity to recognize the loss for tax purposes. That sale will maintain the form of the surrender to the carrier probably; a 1035 exchange isn’t going to cut it.

The unfortunate part of the equation would be that the hefty surrender charge your customer may be charged won’t be deductible. Simplifying a little, the quantity of losing that your customer will understand is the basis in the annuity without the amount received on its surrender (disregarding any surrender charge). 4,000 surrender isn’t deductible. The dilemma surrounding loss deductions for a VA has to do with how the loss is reported. Losing definitely isn’t an investment reduction, so that it can’t be deducted against losses on stock and shared money. But that’s definitely not a negative.

The loss is deductible as an ordinary loss and could be fully deductible in the entire year it’s incurred. In Revenue Ruling 61-201, the IRS considered whether a reduction on what was known as “an individual superior refund annuity contract” was deductible as a typical loss. The IRS’s reasoning was that, under Section 72, a quantity not received as an annuity is taxable as normal income, and that a reduction received under an agreement should get the same treatment-as an ordinary loss. That ruling seems to hold true only for annuities which have a refund feature.

The refund feature eliminates the insurance facet of the contract, and the assumption would be that the agreement was thus joined into as an investment. The open up question is if the reduction should be reported as a Miscellaneous Deduction or under Other Gains/Losses on the tax come back. If losing is categorized as a miscellaneous deduction, it’s heading to be at the mercy of the 2% floor and won’t be deductible for choice minimum taxes (AMT) purposes. Classifying losing as “Other” is a little riskier from an IRS examination perspective, but if it’s classified that way it will be completely deductible (no 2% floor) and can still be deductible for AMT purposes.