Annuity Exchange Is Taxable Unless a Direct Exchange

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Posted by Kim Chen on July 19th, 2016

A taxpayer, who intended to exchange an inherited annuity, mistakenly requested a lump-sum payment. After receiving the proceeds, the taxpayer purchased a replacement annuity, using, in part, the funds from the lump-sum payment. Upon receiving a Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-sharing Plans, IRAs, Insurance Contracts, etc.) reporting the lump-sum distribution, the taxpayer asked the IRS to rule that the erroneous distribution from the annuity and the subsequent contribution of those funds to a new annuity would be a tax-deferred exchange under IRC Sec. 1035(a)(3). However, the IRS denied tax-free exchange treatment, ruling that the annuity’s lump-sum distribution was taxable in the year received. Ltr. Rul. 201625001.