I’m a lawyer, but I don’t practice tax law, and, as we all know, “You either practice tax law, or you malpractice tax law.” Nonetheless, this question came up at work recently, and I did some research on it, and if I’m reading the law properly (a big “if”), this is a really strange anomaly in the U.S. Tax Code.
Basically, two people who have been working in the insurance and annuities field for decades told me, individually, that if an annuity is pledged as collateral for a loan, the annuity’s value (minus the basis) is immediately considered taxable gain to the annuitant, to the extent of the loan.
When the first guy told me, I thought he had to be crazy, but when someone else told me, I decided to look it up, and I think it might be correct.
Here’s the relevant section, Title 26, Section 72:
The “paragraph (2)(B)” referred to basically says that only the gain, and not the basis, in the amount is to be considered taxable gain.
Maybe I’m reading this wrong; I’m certainly no tax expert, and the IRS rules are, as usual, written clear as mud. Nonetheless, that’s what it seems to me to be saying.
This makes no sense to me, though. The annuitant hasn’t given up the annuity, hasn’t realized any income from it; he has just granted a perfected security interest in it. Isn’t it completely against most of the policy behind the tax code to exact tax from someone in a year in which they haven’t actually received any of the income they’re being taxed on?
Granted, the annuitant is receiving the value of the loan for which the annuity is pledged as collateral, but that’s not taxable income, because it’s accompanied by a contemporaneous promise to repay; he’s going to pay tax on that money later, when he gets the actual income that he’ll use to repay the loan.
Anyone? Ideas? I’m at a loss here.
(Insert usual disclaimers: I’m not looking for qualified tax advice, won’t hold the posters or the Reader responsible, don’t plan to use any information for actual purposes without verifying with a tax pro, etc.)
