Penelope purchased an annuity contract that cost $45,000. The contract will pay Penelope $600 per month for 10 years after she reaches the age of 62. During the current year, Penelope turns 62 and receives 4 payments under the contract. The amount Penelope may exclude from taxable income as a return of capital on this years payments is:
A)$692
B)$900
C)$1,500
D)$2,250
E)$2,400

Question

Quizplus · Accepted Answer

To calculate the amount of return of capital that Penelope may exclude from taxable income, we need to use the exclusion ratio. This ratio is calculated by dividing the investment in the contract ($45,000) by the expected return over the life of the contract.

The expected return is calculated by multiplying the monthly payment by the number of months in the payout period (10 years x 12 months = 120 months).

So, the expected return is:
$600 x 120 = $72,000

The exclusion ratio is:
$45,000 / $72,000 = 0.625

This means that 62.5% of each payment Penelope receives is considered a return of capital and can be excluded from taxable income.

For the current year, Penelope received 4 payments, so the total amount she received is:
$600 x 4 = $2,400

To calculate the amount of return of capital she can exclude from taxable income, we multiply the total amount by the exclusion ratio:
$2,400 x 0.625 = $1,500

Therefore, the correct answer is C) $1,500.

Penelope Purchased an Annuity Contract That Cost $45,000