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Regulation and Compliance > Federal Regulation > IRS

IRS Changes Annuity Partial Exchange Rules

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WASHINGTON BUREAU — The Internal Revenue Service (IRS) has changed the rules governing partial exchanges of annuity contracts.

The IRS is reducing the period of time it will consider when reviewing a partial exchange to 6 months, from 1 year.

The IRS made the change in Revenue Procedure 2011-38, a document that also eases some other limits on partial exchanges. The new revenue procedure, which amends Revenue Procedure 2008-24, will be effective for exchanges completed on or after Oct. 24.

Ben Terner, managing director of the Einstein Group L.L.C., New York, a financial services consulting firm, says the revenue procedure applies primarily to exchanges in which cash value is involved.

Section 1035 of the Internal Revenue Code (IRC) gives a taxpayer the ability to exchange one annuity for another without recognizing a taxable gain or loss.

IRC Section 1035 recognizes that tax-free exchange treatment is appropriate for “individuals who have merely exchanged one insurance policy for another better suited to their needs,” according to Terner, who is a member of the panel of experts at AdvisorFX and AdvisorFYI, Summit Business Media publications,

In a partial exchange, an annuity holder moves a portion of the cash surrender value of one annuity into an annuity issued by another company.

When the IRS issued the 2008 revenue procedure, it provided Section 1035 treatment for a partial exchange if no amount was withdrawn from, or received in connection with the surrender of, either of the contracts involved in the exchange during the year beginning on the date of transfer, or if the taxpayer could show that one of a number of life-changing events listed in IRC Section 72(q)(2), or a similar life-changing event, such as divorce, had occurred.

The new procedure shortens the period under consideration to 180 days.

The 2008 procedure was changed because taxpayers who have reached the age of 59 1/2 , or are dying or disabled, have reported having difficulty with applying the procedure, IRS officials say.

Taxpayers have complained, for example, that a 12-month waiting period is administratively difficult, especially when an income tax return has already been filed for the year an exchange took place.

Taxpayers also have complained that, under the 2008 procedure, it is unclear how an exchange that does not qualify as tax-free should be characterized.

In the new, 2011 procedure, the IRS has eliminated a rule requiring that a taxpayer involved in a tax-free partial annuity exchange become 59 1/2 , be dying or disabled, or experience either one of the life-changing events listed in Section 72(q) or a similar life event.

The new procedure also ends the limitation on amounts withdrawn from or received under an annuity contract involved in a partial exchange if the amounts received on an annuity occurred over a period of 10 years or more, or “during one or more lives.”

The IRS has eliminated the automatic characterization of a transfer as either a tax-free exchange under Section 1035 or a distribution taxable under Section 72(e) followed by a payment for a second contract.

The IRS says it will use “general tax principles” to determine how to characterize a transfer.

Other Section 1035 exchange coverage from National Underwriter Life & Health:


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