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The Internal Revenue Service has issued a ruling that could cut taxes for some recipients of deferred annuity death benefits.

The ruling, Revenue Ruling 2005-30, applies to deferred annuities purchased since Oct. 21, 1979, by consumers who die before collecting any annuity income payments.

Annuity death benefits may include the “basis,” or the amount the annuity purchaser contributed to the annuity contract, along with investment gains on the purchaser’s contributions.

The beneficiaries who get the annuity death benefits must include the investment gain component in their taxable income, according to Bradford Poston, an IRS passthroughs and special industries specialist.

But Poston concludes that the beneficiaries can treat the gains as “income with respect to a decedent” rather than as ordinary taxable income.

Although the ruling looks on the surface as if it might increase the heirs’ taxes, it really should give heirs a tax break, says Mark Canter, a senior counsel at the American Council of Life Insurers.

“Any gain in the contract has always been taxable income for the beneficiary,” Canter says.

But the new ruling, which confirms IRS advice given in a private letter ruling in 2000, means that recipients of big annuity death benefits may be able to deduct part of any estate taxes paid on the underlying annuity from their taxable income.

The tax break will help only beneficiaries of annuity purchasers who have estates big enough to pay federal estate taxes, Canter says.

In 2005, federal law exempts estates with less than $1.5 million in assets from estate taxes.

If, for example, a large estate included a $2 million deferred annuity, the estate paid $100,000 in estates taxes on $500,000 in deferred annuity investment gains, and a sole beneficiary received a death benefit that included $500,000 in investment gains, the new ruling might cut the beneficiary’s death benefit-related income taxes 20%, to $148,000 on $400,000 in taxable gains, from $185,000 on $500,000 in total gains.

But Canter emphasizes that, in the real world, situations involving deferred annuity death benefits are usually more complicated and that many factors may affect beneficiaries’ actual tax bills.

The National Association of Insurance and Financial Advisors, Falls Church, Va., has put out a statement emphasizing that the key concern for annuity issuers and distributors should be supporting congressional proposals to exclude up to $20,000 per year in annuity paymnts from taxable income.