Opinion ID: 475836
Heading Depth: 2
Heading Rank: 1

Heading: Taxation of the Annuity

Text: 10 Section 72 of the Internal Revenue Code governs taxation of annuities. 2 It excludes from income a fraction of each payment received as an annuity to reflect the return of capital over the annuity's expected term. 26 U.S.C. Sec. 72(b); 1 Mertens, Law of Federal Income Taxation Sec. 6A.01, at 2 (1986). The amount excluded from income is reflected in the exclusion ratio, which equals the amount invested divided by the expected return. 11 The parties agree that the expected return is $335,000. However, they disagree over LaFargue's investment in the contract, which is defined as 12 (A) the aggregate amount of premiums or other consideration paid for the contract, minus 13 (B) the aggregate amount received under the contract before such date, to the extent that such amount was excludable from gross income under this subtitle or prior income tax laws. 14 26 U.S.C. Sec. 72(c)(1). 15 Generally, consideration paid is the fair market value of the property transferred. 212 Corp. v. Commissioner, 70 T.C. 788, 798 (1978). This rule applies except where the parties are not unrelated parties dealing at arm's-length. 1 Mertens, Sec. 6A.06 at 31; 212 Corp., 70 T.C. at 798. Then, consideration paid is the actuarial value of the annuity at the time of transfer. See Benson v. Commissioner, 80 T.C. 789, 800-03 (1983); 212 Corp., 70 T.C. at 798; Estate of Bell v. Commissioner, 60 T.C. 469, 473 (1973). 3 16 Such is the situation here. This was an intrafamily arrangement. There was no arm's-length bargaining. The annuity payments were funded entirely by assets LaFargue transferred to the trust. 17 Where the fair market value of the property transferred exceeds the value of the annuity received, the excess is deemed a gift absent evidence to the contrary. Benson, 80 T.C. at 800-03; 212 Corp., 70 T.C. at 798; Bell, 60 T.C. at 473. Absent other motivations such as the desire to make a gift, one does not exchange property for contractual rights of substantially lesser market value. 18 By reciting that no interest or discount factor was involved 4 and no gift intended, LaFargue could not nullify the effect of Section 72. See Benson, 80 T.C. at 803 n. 7 (rejecting statement in annuity agreement that no gift was intended). Calculation of the present value of a stream of annuity payments requires use of a discount factor. As the Tax Court held, parties to an annuity contract cannot bargain around this requirement. T.C.M. 1985-90, at 9. 19 LaFargue relies on former Section 483(f)(5), 5 which provided: 20 (5) Annuities.--This section shall not apply to any amount the liability for which depends in whole or in part on the life expectancy of one or more individuals and which constitutes an amount received as an annuity to which section 72 applies. 21 Section 483 involves imputed interest for certain deferred payments. It is an abuse control provision designed to prevent conversion of ordinary income into capital gain. Kingsley v. Commissioner, 662 F.2d 539, 540 (9th Cir.1981). 22 LaFargue offers no support for her argument that former Section 483(f)(5) barred the discounting of an annuity to present value for purposes of determining the Sec. 72(b) exclusion ratio. It cannot serve as a sword to strike down imputing interest to an annuity that was drafted without an interest component. Cf. Garvey, Inc. v. United States, 1 Cl.Ct. 108, 126-29 (1983) (rejecting taxpayer's argument that interest can be deducted by payor of annuity), aff'd, 726 F.2d 1569, 1574 (Fed.Cir.), cert. denied, 469 U.S. 823, 105 S.Ct. 99, 83 L.Ed.2d 44 (1984). 6