On the Taxation of Annuities Held by a Trust (or other non-natural person) . . . .

Thursday, August 30, 2012

Beware!  When selling (or buying) an annuity, keep in mind that annuities are not always tax deferred no matter who the investor might be.  An annuity sold to a corporation or a trust is a case in point.  Under section 72(u) of the Internal Revenue Code, an annuity held by a trust may not be tax deferred.    

The consequences can be dire.  From the perspective of the investor (the corporation or trust buying the annuity) the IRS will be looking for payment of taxes on phantom income The Trust may not have liquidity to make those payments.  At a bare minimum those payments are unexpected and significantly erode the performance of the annuity. 

From the perspective of the representative involved in the sale, the buyer may have legal recourse on a theory of fraud, misrepresentation, suitability, or otherwise based on representations at the time of sale that the annuity would be tax deferred, when the opposite might actually be true, or for failure to disclose that income is not deferred.   The purchase of an annuity by a non-natural person should be a compliance red flagThe customer should be provided a complete disclosure and should be given adequate and correct information on the anticipated after-tax performance of the annuity.

There are a number of exceptions and complexities to tax treatment of annuities that are not held by a natural person.  A qualified accountant or financial services lawyer should be consulted to determine – before the annuity is in place – how the annuity will be treated by the IRS.
For more information, contact Sigmund Schutz or click here for more about Preti Flaherty's Financial Services Group.


Darnell King said...

Why would you not have the lawyers that helped you organize your annuity also make sure that the proper taxes are paid, and how they need to be paid? I feel like that would be partly to blame on the lawyers for not adequately prepping and completing their work!

Mike Cornelia said...

I have been wanting to sell my structured settlement annuity for quite sometime now because I am becoming a little tight with money. I know nothing about this and am trying to get some expert advice. Your blog was very useful, but I still need some more information.

Sigmund Schutz said...

In follow-up to Mr. King's comment, if an attorney (or an accountant) is involved in the sale of the annuity tax issues should absolutely be part of the discussion. The point is that an attorney (or accountant) is not always in the mix. In response to Mr. Cornelia's comment, it is often a bad idea to cash out of a structured settlement annuity. Your best bet may be to contact an independent fee based financial advisor, perhaps someone with the Certified Financial Planner (CFP) designation to evaluate more fully your financial situation, needs, options, and the value of your annuity. You want to be in a position to make an informed decision whether to sell it and, if so, for how much. There are huge regulatory compliance issues and litigation risks for firms cashing out annuities or replacing them with other allegedly better annuities or other financial products. Why? A new product is definately better for whoever is selling it -- they get a commission. That's often not true for the consumer.

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