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IRS Looks At Use Of Check To Move Annuity Funds

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The Internal Revenue Service has come out with a holding that could affect efforts to shift assets from one annuity to another without triggering income tax problems.

A taxpayer cannot shift assets from one annuity contract to another through a tax-free Section 1035 exchange by endorsing a check from one insurance company over to a second insurance company, according to Josephine Firehock, a financial institutions and products specialist at the Internal Revenue Service.

If a taxpayer tries to shift assets from one annuity contract to another by endorsing an insurance company check that is issued to the taxpayer, the transaction “does not qualify as a tax-free exchange under Section 1035(a)(3),” Firehock writes in IRS Revenue Ruling 2007-24. “Instead, the amount received is taxable.”

The revenue ruling deals with the case of a taxpayer who held an annuity outside of a retirement plan or other account that qualified for special tax breaks.

The taxpayer tried to persuade the insurance company that sold the original annuity to transfer the annuity assets to the manufacturer of a second annuity by sending a check directly to the second company.

The first company refused. Instead, it issued a check that named the taxpayer as the payee.

The taxpayer tried to shift assets into a second annuity by endorsing the check over to the second insurer.

The taxpayer never deposited the check.

Section 72(a) of the Internal Revenue Code requires taxpayers to include most annuity payments in gross income.

IRC Section 1035 permits taxpayers to avoid paying income taxes on annuity distributions when they are exchanging one annuity contract for another annuity contract.

In a 2002 revenue ruling, an IRS official held that a taxpayer could implement a tax-free Section 1035 exchange by assigning an annuity contract issued by one insurance company to a second insurance company and having the second company deposit the cash surrender value of the contract into a pre-existing annuity contract owned by the same taxpayer, Firehock writes.

“In the present case, there was no actual exchange of annuity contracts; nor did A assign the [Insurance Company 1] contract to [Insurance Company 2]; nor was there a direct transfer from IC1 to IC2 of the cash value of the old contract in exchange for the new contract,” Firehock writes. “Neither Section 1035 nor the regulations make any special provision for the purchase of an annuity contract with amounts distributed to the policyholder under another contract.”

A copy of the ruling is on the Web


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