May I use general rule to calculate taxable amount for payments from nonqualified variable annuity with lifetime income rider, where 1099-R shows distribution is fully taxable in box 2a?

[wall13]

I began receiving periodic annuity payments from a nonqualified variable annuity in 2020. These payments are for lifetime income under a guaranteed minimum withdrawal benefit rider (GMWB). My 1099-R shows the taxable amount in box 2a as equal to the gross distribution in box 1. No boxes are checked in 2b. The distribution code in box 7 is 7D. The annuity company says that earnings are paid first, so that is why the full distribution is taxable. IRS publications 575 and 939 do not seem to address this situation for periodic payments; however, I have found some articles on annuities that indicate that periodic payments from lifetime income riders are not treated the same as periodic payments from an annuity that has been annuitized. That is, that they are taxable under the last-in-first-out method so that payments are fully taxable until earnings having been paid out, but not taxable once the cost basis has begun to be paid. If this is the case, may I still use the general rule to exclude a portion of the payment to figure a taxable amount that would be different from the taxable amount reported to the IRS in box 2a, and then use that exclusion ratio in future tax years instead of the taxable amount in box 2a of the 1099-R?

[dmertz]

Earnings are generally paid first only if the periodic payments are [Edit] not in the form of an immediate annuity after annuitizing, but there are a few exceptions to this rule.  Based on what the annuity company told you, apparently the annuity company believes that the payments that you are receiving are not periodic payments from an immediate annuity but are instead non-periodic payments from the deferred annuity that just happen to be equal amounts distributed on a regular basis.  As such, distributions are fully taxable until all earnings have been distributed.

Still, I'm not sure how you could be receiving lifetime GMWB benefits without annuitizing.  Simply arranging a distribution schedule where a specified amount is paid at regular intervals would not necessarily mean that you annuitized the deferred annuity and may be resulting in the recalculation and lowering of your GMWB.  You need to sort this out with the annuity company.

If the annuity has been annuitized but the annuity company did not know the amount of your investment in the contract, they should have left box 2a blank and marked box 2b Taxable amount not determined, in which case you would need to calculate the taxable amount using the General Rule.  However, the fact that they put a taxable amount in box 2a indicates suggests that it would be inappropriate to use any other amount as the taxable amount.  Specifying a different taxable amount would likely result in a letter from the IRS indicating an underreporting of income.

[wall13]

Thank you for your reply.

[sgtstocker]

That you for the description you provided.  My circumstance is almost identical to the one posed here.  Yes, mine has been annuitized and I see you say that 1099 should have been issued with 2a blank and not determined checked.  Mine  has 1 and 2a same .  Is it reasonable to have my payor (lincoln financial) reissue a corrected 1099r so I can use the general calculation and not pay tax on full amount of payments received?  Thus preventing a challenge from IRS.  Also would like to refile my 2020 taxes as it has the same issue.

Please advise and thank you in advance for your assistance.

[dmertz]

My original reply inadvertently omitted the word "not" from the first sentence, so I fixed that.  It's not clear to me why any annuity that was annuitized would not be partially nontaxable unless all of the investment in the contract had already been paid out, resulting in all subsequent distributions being fully taxable.  The is a provision in section 72 of the tax code that describes partial annuitization that might cause the contract to be treated as two separate annuities, so it's possible that payment of a GMWB might be considered to be from a separate contract that is not being paid out as an annuity and has no investment in the contract.  Also, if there is a loan treated as a distribution, that amount is treated as an amount not treated as an annuity, but I don't see how a GMWB would have anything to do with a loan.

Box 2a should only be blank if box 2b Taxable amount not determined is marked.

You might read section 72 to see if anything stands out, but it's a complicated section of the tax code:

https://www.law.cornell.edu/uscode/text/26/72