Simplified Method for annuity with IRA/SEP/SIMPLE box checked

[LeoK]

I am getting a payout from an annuity.  Some of the funds used to purchase the annuity came from a traditional IRA , so I need to use the simplified method to determine the taxable part of the payout.  On the 1099-R form the IRA/SEP/SIMPLE box is checked.  The distribution code is 7.  When I try to fill out the simplified method form, turbo tax gives me an error, complaining that the IRA/SEP/SIMPLE box is checked.  If I uncheck the box the error message goes away.  The payout came from the annuity, not the IRA so I should be able to do this.  I checked with the issuer of my 1099-R and they insist that the form is correct.  They also confirmed that the distribution came from the annuity and not the IRA.

I think that the IRS will complain if I uncheck the box.  How can this be done correctly?

[DavidD66 · Accepted solution]

The annuity is either a qualified annuity (IRA, SEP, Simple) or it's a non-qualified annuity.  You can't mix qualified and non-qualified funds to purchase a single annuity.  If you used IRA funds to purchase the annuity, and didn't take a taxable distribution, it would have been a rollover, and you have a qualified annuity - an annuity inside an IRA.  If you took a distribution, then you would have (or at least should have) reported that on your tax return for the year you took the distribution.  If you then used those funds to purchase an annuity, you would have a non-qualified annuity.  Given that the issuer of the 1099-R insists that the form is correct, it sounds to me like you have a distribution from an IRA/SEP/SIMPLE account that has the invested the funds in the account in an annuity.  That would be reported like any other distribution from an IRA/SEP/SIMPLE.  If there is an after-tax component to the account, you calculate the taxable and non taxable amounts on Form 8606 - Nondeductible IRAs.   

[LeoK]

Thank you for your assistance.  You are correct that this is an IRA/SEP/SIMPLE  account with some funds invested in an annuity.  The IRS rules for an annuity indicate that the Simplified Method should be used when not all of the funds were pretax.  However, after reading this section again, I believe that it does not apply to IRA funds, since it refers only to employee plans.  Publication 590-B specifically says that annuities within an IRA should use form 8606.  So, I believe that your guidance is correct.  

Thanks again.