Loss on surrender of a variable annuity

[BAGEL2]

I surrendered a variable annuity. The company in a letter advised me of my loss. I called them and they told me the loss would not appear on a 1099-R. I did get a 1099-R for the taxable portion of the withdrawals made during 2019. . In my research it was clear it is not a schedule D capital loss. What I read was split between those saying it is a deduction subject to the 2% limitation and those that say it can be taken as a misc gain or loss on the 1040 line 7A, schedule 1 using form 4797. Apparently there are no concrete IRS regulations or ruling. The company would provide no guidance which I assumed would be their position. What does the group think?

[MarilynG1]

Advice from @Superdmertz may help you: 

"In recent years nonrecoverable basis was reportable as a miscellaneous deduction subject to the 2% of AGI floor (§?67), but that deduction has been suspended by the Tax Cuts and Jobs Act of 2017 for tax years 2018 thorugh 2025.

From IRS 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.

Generally, the loss is claimed as a miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-in-come limit on Form 1040, Schedule A. However, for tax years after beginning December 31, 2017, and before January 1, 2026, these miscellaneous itemized deductions have been suspended. Therefore, a deduction for these losses is not allowed.

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

[Anonymous · Accepted solution]

some guidance 

As you suggest, there is a way to possibly use this to your advantage by declaring the variable annuity a "loss" and using this to reduce your income taxes.

First, you have to sell or surrender the annuity. 

To calculate your gain or loss, you have to figure your "cost basis." This is the total amount of principal you contributed, minus any withdrawals you made. From this, subtract the proceeds from the sale. If you paid a surrender charge, you have to add this back in.

Using an example, we'll assume your total contribution to your variable annuity was $80,000, that you took $15, 000 in withdrawals, that the annuity is worth $60,000 on the day you cash it out, and that you have to pay a $2,000 surrender charge for canceling the contract early.

Although you receive a check for $43,000  ($60k - $15k - $2k , your reportable loss is $5,000  ($80k-#15K-$60k) -- not $7,000. The $2,000 surrender charge is not considered part of your loss. One bright spot: even if you are under age 59 1/2, there will be no 10% early withdrawal penalty from by the federal government because, as mentioned above, this is only imposed on gains.

Now here's where we enter the "murky" zone: Where on your tax return do you report this loss?

A loss on a variable annuity is not considered an "investment" loss. You cannot use it to offset income from investments such as mutual funds or the profit you realized from the sale of stock. Instead, it is classified as an "ordinary" loss, which means it is (potentially) fully deductible in a single tax year.

As a Misc itemized deduction - it would not be deductible due to changes in the tax laws -  the conservative approach

Now here's the more gutsy approach: Instead of listing your annuity loss as a non deductible expense some tax experts think it is more appropriate for it to be listed under "Other Gains/Losses"   schedule 1 line 4  sure you seek the help of an experienced tax professional and investment advisor.

By the way, if you take the more aggressive approach and happen to end up in tax court, you will not only be immortalized in the annals of Tax History, you will become a saint of sorts to those who toil in the tedious theater of tax law: every CPA in America will appreciate you settling this issue once and for all!

the aggressive approach is based on Revenue Ruling 61-201, 1961-2, CB46.  

can not find it in a web search or on IRS website.

if the loss is significant it could generate an audit.  you will want a pro at your side, so I would suggest getting them involved in the prep of your 2019 return.  they will have to defend their treatment  

[BAGEL2]

Thank you. Very helpful.