Variable Annuity Loss

[activeonlooker]

Based on what I have read, IRS would like to see an annuity loss reported as a misc itemized deduction subject to 2%. Have also seen a more aggressive position reporting the loss on 4797 part II which flows to page 1 of the 1040 - obviously the better choice taxwise. Anybody have any experience taking the loss on 4797 rather than sched A? Or any comments/references regarding this would be appreciated.

[mwcpa]

I found this from an article....( www.advisorone.com/2011/12/06/year-end-tax-planning-are-variable-annuity-losses?page=2 )

"In Revenue Ruling 61-201, the IRS considered whether a loss on what was referred to as “a single premium refund annuity contract” was deductible as an ordinary loss. The IRS’s reasoning was that, under Section 72, an amount not received as an annuity is taxable as ordinary income, and that a loss received under a contract should be given the same treatment—as an ordinary loss. That ruling appears to hold true only for annuities that have a refund feature. The refund feature eliminates the insurance aspect of the contract, and the assumption is that the contract was thus entered into as an investment.

The open question is whether the loss should be reported as a Miscellaneous Deduction or under Other Gains/Losses on a tax return. If the loss is classified as a miscellaneous deduction, it’s going to be subject to the 2% floor and won’t be deductible for alternative minimum tax (AMT) purposes. Classifying the loss as “Other” is a bit riskier from an IRS examination perspective, but if it’s classified that way it will be fully deductible (no 2% floor) and will still be deductible for AMT purposes.

Obviously, your clients will want to classify the loss as “Other,” but there’s no clear authority for that move."

Here is the IRS position on the subject..... ( www.irs.gov/publications/p575/ar02.html#en_US_2011_publink1000226856 ) pub 575

"Losses. You may be able to claim a loss on your return if you receive a lump-sum distribution that is less than the plan participant's cost. You must receive the distribution entirely in cash or worthless securities. The amount you can claim is the difference between the participant's cost and the amount of the cash distribution, if any.

To claim the loss, you must itemize deductions on Schedule A (Form 1040). Show the loss as a miscellaneous deduction subject to the 2%-of-adjusted-gross-income limit.

You cannot claim a loss if you receive securities that are not worthless, even if the total value of the distribution is less than the plan participant's cost. You recognize gain or loss only when you sell or exchange the securities.

A loss under a nonqualified plan, such as a commercial variable annuity, is deductible in the same manner as a lump-sum distribution. "

[activeonlooker]

Thanks, MWCPA. I've seen numerous discussion about the above reporting. Have you, or do you know of anyone who has taken the more aggressive position of claiming the loss on 4797?

[mwcpa]

I have never taken or seen the 4797 route taken.....

the loss had better be worth the cost if you think you can prevail on a position that is opposite of the position take by IRS on this matter.... another fine way Congress "punted" the ball away.... they could easily address the matter one way or another.... but IRS position on the treatment is consistent with other tax deferral/tax free investments, such as non deductible IRAs and Roth IRAs....

[rangerj]

If you take the aggressive position then support it with "reasonable authority", say for example the Revenue Ruling cited above, and "disclose" it if you want to avoid penalties IF the return is audited. Best wishes.

[mwcpa]

good point ranger..... whenever you want to take a position that is different than the norm provide all of the required disclosures, including the reasonable authority for the basis of your position.... just because you disclose does not mean you'll get a "get out of jail free" card.... you need a reasonable basis supported by a reasonable authority for your positions (this blog is not reasonable authority)

[activeonlooker]

Thanks for the input.