My father's non-qualified annuity 1099-R states the entire distribution is taxable. The distribution code is 7D. The agent said because the distribution is all earnings. I show him IRS's General Rule and think a part of the distribution must be the principle and not taxable. He said that not how they do it in Prudential.What the agent said is consistent with the company's Q&A.https://www.annuities.prudential.com/view/page/investor/17095#11Q.Why is my entire distribution taxable?For Non-Qualified contracts there are 2 possible reasons:The distribution was all earnings; it did not contain any return of cost basis.The contract is aggregated. But it's in conflict with what IRS's General Rule.https://www.irs.gov/taxtopics/tc411#:~:text=The%20General%20Rule,tables%20that%20the%20IRS%20issues.The General RuleIf you receive annuity payments from a nonqualified retirement plan, you must use the General Rule. Under the General Rule, you figure the taxable and tax-free parts of your annuity payments using life expectancy tables that the IRS issues.He is confident about their 1099-R and has decline my requests to appeal the 1099-R.Am I missing some special rules? If not, what are my options?

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Conflict information on non-qualified annuity taxable amount

Forum|Forum|5 years ago
June 24, 2020
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My father's non-qualified annuity 1099-R states the entire distribution is taxable. The distribution code is 7D. The agent said because the distribution is all earnings. I show him IRS's General Rule and think a part of the distribution must be the principle and not taxable. He said that not how they do it in Prudential.

What the agent said is consistent with the company's Q&A.

https://www.annuities.prudential.com/view/page/investor/17095#11

Q.Why is my entire distribution taxable?

For Non-Qualified contracts there are 2 possible reasons:

The distribution was all earnings; it did not contain any return of cost basis.
The contract is aggregated.

But it's in conflict with what IRS's General Rule.

https://www.irs.gov/taxtopics/tc411#:~:text=The%20General%20Rule,tables%20that%20the%20IRS%20issues.

The General Rule

If you receive annuity payments from a nonqualified retirement plan, you must use the General Rule. Under the General Rule, you figure the taxable and tax-free parts of your annuity payments using life expectancy tables that the IRS issues.

He is confident about their 1099-R and has decline my requests to appeal the 1099-R.

Am I missing some special rules? If not, what are my options?

Not A Product Question

Best answer by SusanY1

A non-qualified annuity and a non-qualified retirement plan are not the same thing.

The general rule applies to non-qualified retirement plans paid as annuities but it doesn't apply to standard annuities.

Your father's non-qualified annuity is not a non-qualified retirement plan. It just simply an annuity that wasn't also a qualified plan of some sort (such as an IRA.)

After a period of time, or in the case of certain types of annuities, the principal will be fully distributed and then the entire amount becomes taxable.

While your Prudential representative perhaps didn't explain things very well, he is correct. If the distribution was all earnings, then it is fully taxable.

SusanY1Answer

A non-qualified annuity and a non-qualified retirement plan are not the same thing.

The general rule applies to non-qualified retirement plans paid as annuities but it doesn't apply to standard annuities.

Your father's non-qualified annuity is not a non-qualified retirement plan. It just simply an annuity that wasn't also a qualified plan of some sort (such as an IRA.)

After a period of time, or in the case of certain types of annuities, the principal will be fully distributed and then the entire amount becomes taxable.

While your Prudential representative perhaps didn't explain things very well, he is correct. If the distribution was all earnings, then it is fully taxable.

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sciaccamar

I have strong doubts about the reply given, at least per the 2023 version of IRS Pubs 525 and 939. I can find no distinction made about the General Rule between (non-qualified) annuities and retirement plans. Instead, the salient distinction is between periodic payments and non-periodic (withdrawals). The latter are not eligible for amortized cost recovery until all earnings are withdrawn, then return of invested capital takes place.

Pub939 states: "In general, you can recover your net cost of the pension or annuity tax free over the period you are to receive the payments." Also: " An annuity is a series of payments under a contract made at regular intervals over a period of more than 1 full year. They can be either fixed (under which you receive a definite amount) or variable (not fixed). You can buy the contract alone or with the help of your employer. Note. Distributions from pensions and annuities follow the same rules as outlined in this publication unless otherwise noted."

Unless someone can point out a specific IRS statement that excludes standard annuities from using the General Rule, I plan to use this approach and make an adjustment to the Taxable Amount that I believe was inaccurately reported in the 1099-R by the payer (insurance company).

NCPERSON1

@sciaccamar suggest asking the firm what the cost basis is in the annuity. if it has not changed, then all the payments you received are taxable. if the cost basis has changed, you have an argument.

It might be worth posting the details of your annuity as it is hard to either support your contention or refute it without that. There are a number of examples of how this works in Pub 939 - did you read them?

Personally, companies have lawyers and compliance experts that ensure these are contracts are reported correctly and adhere to law. Do you have that level of expertise to make a different decision? Since the IRS has a copy of that 1099-R already (as it is reported by the firm), if you tax return varies from that reporting, it risks an audit and / or withholding of any refund. Best to discuss with the firm rather than just making your own decision.