Tax Facts
580 / What are the income tax consequences when a deferred annuity contract is transferred as a gift?
An individual who transfers a nonqualified deferred annuity contract issued after April 22, 1987, for less than full and adequate consideration is treated as having received “an amount not received as annuity” ( Q 515). Thus, the individual transferring the contract realizes in the year of the transfer any gain on the contract (the excess of the cash surrender value over the investment in the contract).1
The IRS has ruled privately that the distribution of an annuity contract by a trust to a trust beneficiary will not be treated as an assignment for less than full and adequate consideration because the trust as transferor is not considered an individual.2 In addition, this rule also does not apply to transfers between spouses (or between former spouses incident to a divorce and pursuant to an instrument executed or modified after July 18, 1984), except that it does apply to a gift of a contract in trust for such a spouse to the extent that gain must be recognized because of any loan to which the contract is subject ( Q 106).
In the case of an annuity contract issued prior to April 23, 1987, if the cash surrender value at the time of the gift exceeds the donor’s cost basis and the donee subsequently surrenders the contract, the donor must, in the year of the surrender (which might not be the year of gift), report as taxable income the “gain” existing at the time of the gift. In other words, the donor is taxed on the difference between the premiums the donor had paid (less any excludable dividends the donor has received) and the cash surrender value of the contract at the time of the gift, but not until the donee surrenders the contract. The balance of the gain, if any, is taxed to the donee. Thus, in the case of a pre-April 23, 1987 contract, the proper year for the donor to include the gain in the donor’s gross income is the year in which the contract is surrendered by the donee; with a post-April 22, 1987 annuity, gain is always recognized at the time (in the year) that the transfer occurs.3
Subsequent annuity payments under a contract that has been transferred as a gift are taxed under the annuity rules ( Q 527 to Q 552). With respect to gifts of annuities issued after April 22, 1987, the amount of gain, if any, that is included in the transferor’s income as a result of the transfer will increase the transferee’s investment in the contract for the purposes of calculating the exclusion ratio.4 If the contract was issued before April 23, 1987, all premiums paid and excludable dividends received by both the donor and donee prior to the commencement of the annuity payments are taken into account in determining the investment in the contract. The annuity starting date and expected return are determined as though no transfer has taken place.5 However, the IRS has not ruled on whether, if the contract was transferred when the cash surrender value exceeded the donor’s cost basis, the donor must include any portion of the payments in the donor’s gross income or how such portion would be determined.
Where a gift is conditioned on payment by the donee of the donor’s gift tax liability, a court has ruled that income is realized by the donor to the extent the gift tax exceeds the donor’s basis in the property.6 The gain is included in the donor’s income for the year in which the gift tax is paid by the donee.7 However, payment of federal or state gift tax by the donee (or agreement to pay such tax) does not result in income to the donor in the case of net gifts made before March 4, 1981.8
If the contract transferred is subject to a nonrecourse loan, the transferor’s obligation under the loan is discharged and the amount of the loan is treated as an amount received with the result that gain is recognized to the extent the loan exceeds the adjusted basis.9
If the gift is to a corporation or other nonnatural person, see Q 513.
1. IRC § 72(e)(4)(C).
2. Let. Ruls. 9204010, 9204014.
3. Rev. Rul. 69-102, 1969-1 CB 32.
4. IRC § 72(e)(4)(C)(iii).
5. Treas. Reg. § 1.72-10(b).
6. Diedrich v. Commissioner, 82-1 USTC ¶ 9419 (1982).
7. Weeden v. Commissioner, 82-2 USTC ¶ 9556 (9th Cir. 1982).
8. TRA ’84, § 1026.
9. Treas. Reg. § 1.1001-2(a).
The IRS has ruled privately that the distribution of an annuity contract by a trust to a trust beneficiary will not be treated as an assignment for less than full and adequate consideration because the trust as transferor is not considered an individual.2 In addition, this rule also does not apply to transfers between spouses (or between former spouses incident to a divorce and pursuant to an instrument executed or modified after July 18, 1984), except that it does apply to a gift of a contract in trust for such a spouse to the extent that gain must be recognized because of any loan to which the contract is subject ( Q 106).
In the case of an annuity contract issued prior to April 23, 1987, if the cash surrender value at the time of the gift exceeds the donor’s cost basis and the donee subsequently surrenders the contract, the donor must, in the year of the surrender (which might not be the year of gift), report as taxable income the “gain” existing at the time of the gift. In other words, the donor is taxed on the difference between the premiums the donor had paid (less any excludable dividends the donor has received) and the cash surrender value of the contract at the time of the gift, but not until the donee surrenders the contract. The balance of the gain, if any, is taxed to the donee. Thus, in the case of a pre-April 23, 1987 contract, the proper year for the donor to include the gain in the donor’s gross income is the year in which the contract is surrendered by the donee; with a post-April 22, 1987 annuity, gain is always recognized at the time (in the year) that the transfer occurs.3
Subsequent annuity payments under a contract that has been transferred as a gift are taxed under the annuity rules ( Q 527 to Q 552). With respect to gifts of annuities issued after April 22, 1987, the amount of gain, if any, that is included in the transferor’s income as a result of the transfer will increase the transferee’s investment in the contract for the purposes of calculating the exclusion ratio.4 If the contract was issued before April 23, 1987, all premiums paid and excludable dividends received by both the donor and donee prior to the commencement of the annuity payments are taken into account in determining the investment in the contract. The annuity starting date and expected return are determined as though no transfer has taken place.5 However, the IRS has not ruled on whether, if the contract was transferred when the cash surrender value exceeded the donor’s cost basis, the donor must include any portion of the payments in the donor’s gross income or how such portion would be determined.
Where a gift is conditioned on payment by the donee of the donor’s gift tax liability, a court has ruled that income is realized by the donor to the extent the gift tax exceeds the donor’s basis in the property.6 The gain is included in the donor’s income for the year in which the gift tax is paid by the donee.7 However, payment of federal or state gift tax by the donee (or agreement to pay such tax) does not result in income to the donor in the case of net gifts made before March 4, 1981.8
If the contract transferred is subject to a nonrecourse loan, the transferor’s obligation under the loan is discharged and the amount of the loan is treated as an amount received with the result that gain is recognized to the extent the loan exceeds the adjusted basis.9
If the gift is to a corporation or other nonnatural person, see Q 513.
1. IRC § 72(e)(4)(C).
2. Let. Ruls. 9204010, 9204014.
3. Rev. Rul. 69-102, 1969-1 CB 32.
4. IRC § 72(e)(4)(C)(iii).
5. Treas. Reg. § 1.72-10(b).
6. Diedrich v. Commissioner, 82-1 USTC ¶ 9419 (1982).
7. Weeden v. Commissioner, 82-2 USTC ¶ 9556 (9th Cir. 1982).
8. TRA ’84, § 1026.
9. Treas. Reg. § 1.1001-2(a).
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