Declaring annuity income on your tax return is a relatively easy process. In most cases, you will not have to do any manual calculations, but can simply wait to receive the appropriate form in the mail. This is true for contract holders of commercial annuities. However, if you receive income from a private annuity, then you may have to do some figuring to determine your reportable income.
Wait to receive your Internal Revenue Service Form 1099-R from your annuity carrier. This form is mailed at the end of each year to all annuity holders who received distributions from their contracts. If you do not receive one, contact your carrier if you received distributions and ask them to resend it to you. Some carriers can send you this document via email.
Look in Box 1 of your 1099-R. This shows the amount of your gross annuity distribution. Then Box 2A will show the taxable amount. Box 3 will show any federal tax that has been withheld. Look carefully at all of the other boxes to see what is reported in them as well.
Report the amount of your distribution in Box 2A on your 1040. Also be sure to report the amount of tax withheld on both your federal and state returns. Follow the instructions for the Form 1099-R for the rest of the boxes.
Calculate the exclusion ratio for income received from a private annuity. All annuity payments include a portion of principal in them, and the return of principal is nontaxable. Therefore you must subtract this amount from your payments before reporting taxable income.
Add up the total dollar amount of the payments that you will receive from your annuity and divide your principal invested by that amount. For example, if you invested $100,000 originally and will get a monthly payment of $1500 for 20 years, then you will receive a total of $360,000. $100K / $360K = 28%. Therefore, 28 percent of each payment received is a nontaxable return of principal. The remainder is taxable as ordinary income. This means that the remaining 72 percent of each payment is taxable. 12 payments of $1500 x 72% = $12,960 of income for the year.
Of course, if your annuity payments in the above example began during the year and you only received seven payments, then you would multiply the exclusion ratio by only the dollar amount of those payments for that year.
- Of course, if your annuity payments in the above example began during the year and you only received seven payments, then you would multiply the exclusion ratio by only the dollar amount of those payments for that year.
Mark Cussen has more than 17 years of experience in the financial industry. He received his B.S. in English from the University of Kansas and became a Certified Financial Planner in 2001. He has published financial educational articles on such websites as Investopedia and Money Crashers. He also provides financial education and counseling for members of the U.S. military and their families.