1363

¶ 1363. Annuity rule exclusion available only to natural persons.

If an annuity contract is held by a person who isn't a natural person, the annuity rule ( ¶ 1362 ) doesn't apply. The income on the contract (for the holder's tax year) must be treated as ordinary income received or accrued by the holder during that year. ( Code Sec. 72(u)(1) ) FTC ¶ J-5005 , FTC ¶ J-5006 ; USTR ¶ 724.25 ; Tax Desk ¶ 146,506 A natural person doesn't include a trust or corporation. But holding by a trust, etc., as agent for a natural person is disregarded. ( Code Sec. 72(u)(1) ) FTC ¶ J-5005 ; USTR ¶ 724.25 ; Tax Desk ¶ 146,506

However, an employer that's the nominal owner (agent) of an annuity contract whose beneficial owners are (the employer's) employees is considered to hold the contract. FTC ¶ J-5005 ; USTR ¶ 724.25 ; Tax Desk ¶ 146,506

The natural person rule doesn't apply to contracts: acquired by an estate by reason of the decedent's death; held by a qualified plan or IRA; that are “qualified funding assets” ( ¶ 1390 ); bought by an employer on termination of a qualified plan and held until all amounts under the contract are distributed to the employee (or his beneficiary) for whom the contract was bought; or that are immediate annuities. ( Code Sec. 72(u)(3) ) FTC ¶ J-5007 ; USTR ¶ 724.25 ; Tax Desk ¶ 146,508

(1) In general.
If any annuity contract is held by a person who is not a natural person—

(A) such contract shall not be treated as an annuity contract for purposes of this subtitle (other than subchapter L), and

(B) the income on the contract for any taxable year of the policyholder shall be treated as ordinary income received or accrued by the owner during such taxable year.

For purposes of this paragraph , holding by a trust or other entity as an agent for a natural person shall not be taken into account.

(2) Income on the contract.

(A) In general. For purposes of paragraph (1) , the term “income on the contract” means, with respect to any taxable year of the policyholder, the excess of—

(i) the sum of the net surrender value of the contract as of the close of the taxable year plus all distributions under the contract received during the taxable year or any prior taxable year, reduced by

(ii) the sum of the amount of net premiums under the contract for the taxable year and prior taxable years and amounts includible in gross income for prior taxable years with respect to such contract under this subsection .

Where necessary to prevent the avoidance of this subsection , the Secretary may substitute “fair market value of the contract” for “net surrender value of the contract” each place it appears in the preceding sentence.

(B) Net premiums. For purposes of this paragraph , the term “net premiums” means the amount of premiums paid under the contract reduced by any policyholder dividends.

(3) Exceptions.
This subsection shall not apply to any annuity contract which—

(A) is acquired by the estate of a decedent by reason of the death of the decedent,

(B) is held under a plan described in section 401(a) or 403(a) , under a program described in section 403(b) , or under an individual retirement plan,

(C) is a qualified funding asset (as defined in section 130(d) , but without regard to whether there is a qualified assignment),

(D) is purchased by an employer upon the termination of a plan described in section 401(a) or 403(a) and is held by the employer until all amounts under such contract are distributed to the employee for whom such contract was purchased or the employee's beneficiary, or

(E) is an immediate annuity.

(4) Immediate annuity.
For purposes of this subsection , the term “immediate annuity” means an annuity—

(A) which is purchased with a single premium or annuity consideration,

(B) the annuity starting date (as defined in subsection (c)(4) ) of which commences no later than 1 year from the date of the purchase of the annuity, and

(C) which provides for a series of substantially equal periodic payments (to be made not less frequently than annually) during the annuity period.

(v) 10-percent additional tax for taxable distributions from modified endowment contracts.

(1) Imposition of additional tax.
If any taxpayer receives any amount under a modified endowment contract (as defined in section 7702A ), the taxpayer's tax under this chapter for the taxable year in which such amount is received shall be increased by an amount equal to 10 percent of the portion of such amount which is includible in gross income.

(2) Subsection not to apply to certain distributions.
Paragraph (1) shall not apply to any distribution—

(A) made on or after the date on which the taxpayer attains age 591/2,

(B) which is attributable to the taxpayer's becoming disabled (within the meaning of subsection (m)(7) ), or

(C) which is part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the taxpayer or the joint lives (or joint life expectancies) of such taxpayer and his beneficiary.

(w) Cross reference.
For limitation on adjustments to basis of annuity contracts sold, see section 1021 .

EXP ¶724.25 Taxation of annuity contracts not held by natural persons.

An annuity contract won't be treated as an annuity contract if it is held by a person who isn't a natural person. The income on the contract for any tax year of the policyholder will be treated as ordinary income received or accrued by the owner during that tax year. Code Sec. 72(u) . Corporations and trusts aren't natural persons according to the '86 TRA Committee Reports at ¶721.01 . However, Code Sec. 72(u)(1) provides that holding by a trust or other entity as an agent for a natural person won't be subject to the restriction rule.

The General Explanation of the Tax Reform Act of 1986 (Blue Book) prepared by the Staff of the Joint Committee on Taxation says that in the case of a contract where the nominal owner is a nonnatural person such as a corporation or trust but the beneficial owner is a natural person, the contract is treated as held by the natural person. The Blue Book gives as an example a case where an employer holds a group policy to meet State group policy requirements, but has no right to any amounts contributed to the contract and all contributed amounts are employee contributions. In such a case, the employer is only the nominal holder of the contract and the contract isn't treated as held by a nonnatural person.

The above rules don't apply for purposes of Subchapter L (relating to taxation of insurance companies). The rules were enacted because of a perception that prior law rules for deferred annuity contracts provided employers with an opportunity to fund deferred compensation on a tax-favored basis without providing benefits under qualified plans, which are subject to many restrictions.

Income.

Income on the contract for any tax year of the policyholder is the excess of net surrender value of the contract as of the close of the tax year plus all distributions under the contract received during the tax year or any prior tax year over the sum of the net premiums under the contract for the tax year and prior tax years and amounts includible in gross income for prior years for the contract. Net premiums means the amount of premiums paid under the contract reduced by any policyholder dividends. If necessary to prevent avoidance of Code Sec. 72(u) , the IRS may substitute “fair market value of the contract” for “net surrender value of the contract” in the above rules. Code Sec. 72(u)(2) .

Exceptions.

Code Sec. 72(u)(3) provides for exceptions to the Code Sec. 72(u) rules restrictions deferred annuity contracts. The rules won't apply to any annuity contract acquired by the estate of a decedent by reason of the decedent's death. They also won't apply to any annuity contract held under:

an Code Sec. 401(a) qualified employee benefit plan
an Code Sec. 403(a) qualified annuity plan
an Code Sec. 403(b) program (providing benefits to employees of public schools and certain charities), and
an IRA.

The Code Sec. 72(u) deferred annuity contract rule doesn't apply to an annuity contract bought by an employer on termination of an Code Sec. 401(a) or Code Sec. 403(a) qualified plan and held by the employer until all amounts under the contract are distributed to the employee for whom the contract was bought (or the employee's beneficiary).

Immediate annuities are also excepted from the Code Sec. 72(u) rule for contracts not held by natural persons. An immediate annuity is an annuity bought with a single premium or annuity consideration, with an annuity starting date no later than one year from the date the annuity was bought, and providing for a series of substantially equal periodic payments during the annuity period. The periodic payments must be made no less frequently than annually. The annuity starting date is the first day of the first period for which an amount is received as an annuity under a contract.

1) In general.
If any annuity contract is held by a person who is not a natural person—