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Poor Health Does Not Accelerate Recovery of Basis in Annuity Oliver, TC Summary Opinion 2018-16

Estate Planning Journal

The Tax Court, in Oliver1, held that a taxpayer, despite assertions that he was in poor health, may not accelerate the recovery of his investment in an annuity contract but must instead use the life expectancy recovery method prescribed in the Code.

Facts

The taxpayer retired in 2007 at 55 years of age and began receiving annuity payments from a qualified employer retirement plan. During 2014, the taxpayer received retirement distributions of $31,973. For 2014, the retirement plan administrator reported to the IRS that $27,850 of the $31,973 in retirement distributions was taxable. On his 2014 Form 1040, the taxpayer reported taxable retirement distributions of $20,650 from the retirement plan. In the notice of deficiency, the IRS determined that the taxpayer should have reported an additional $7,200 of taxable retirement distributions.

Analysis

Section 61(a) defines "gross income" broadly as "all income from whatever source derived." Sections 61(a)(9) and (11) provide that annuities and pensions are among the forms of income within the purview of Section 61(a) . Section 72 sets forth the specific rules applicable to taxation of annuities and distributions from qualified employer retirement plans. Section 72(a) provides that a taxpayer must include in gross income any amount received as an annuity, while Section 72(b) allows the taxpayer a tax-free recovery of the taxpayer's investment in the contract. Section 72(c)(1)(A) defines the term "investment in the contract" as "the aggregate amount of premiums or other consideration paid for the contract."

Section 72(d) mandates a "simplified method" of recovering the investment in the contract for amounts received as an annuity under a qualified employer retirement plan. Section 72(d)(1)(B) provides that the simplified method excludes from gross income the amount of any monthly annuity payment that does not exceed the amount obtained by dividing the taxpayer's investment in the contract by the number of anticipated payments. Section 72(d)(1)(B)(iii) provides that if the age of the annuitant on the annuity starting date is not more than 55, the number of anticipated payments is 360.

The parties agreed that the taxpayer's investment in the contract was $123,664. The IRS argued that the taxpayer may exclude from gross income each month $343.51 ($123,664 / 360 = $343.51) of the taxpayer's annuity payment. Therefore, the IRS contended that the taxpayer was entitled to a yearly exclusion of $4,122.12 ($343.51 × 12 = $4,122.12). Consequently, the IRS argued that the taxpayer must include in gross income $27,850 of the $31,973 annuity distributions ($31,973 - $4,122.12 = $27,850.88).

The taxpayer argued that under the simplified method it would take him 30 years to recover his investment in the contract, at which time he would be 85 years old. He contended that this was unfair because his preexisting medical conditions caused his life expectancy to be much shorter than that. Accordingly, the taxpayer contended that fairness dictated that he should be allowed to calculate the nontaxable portion of his annuity payments based on a shorter life expectancy.

The court recognized the inequity that the taxpayer perceived in the application of the simplified method under the circumstances of his case. The court stated, however, that absent some constitutional defect in the law, which it did not find, it was constrained to apply the law as written, notwithstanding any countervailing equitable considerations. Accordingly, the court sustained the determination of the IRS.

Comments

This case is an example of the concept that where the Code prescribes specific rules regarding the tax treatment of an item, courts lack equitable remedies to prevent inequitable results. While the court in this case was very sympathetic to the taxpayer, the court nevertheless refused to adopt the taxpayer's position that he should be allowed to use a tax treatment for the taxation of his retirement plan payment not explicitly set forth in the Code.

1 TC Summary Opinion 2018-16.

Frank Baldino is an estates and trusts attorney who helps people throughout the greater Washington, DC area protect assets for their families and future generations through careful estate tax planning. For more information, contact Frank at 301-657-0175 or fsbaldino@lerchearly.com.

The article originally appeared in the August 1, 2018 edition of Estate Planning Journal, a monthly periodical with a national circulation directed to estate planning professionals such as lawyers, accountants, financial advisers, and trust officers that offers readers the newest and most innovative strategies for saving taxes, building wealth, and managing assets.

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