Fran purchased an annuity that provides $12,000 quarterly payments for the next 10 years. The annuity was purchased at a cost of $300,000. How much of the first quarterly payment will Fran include in her gross income?

Question

Quizplus · Accepted Answer

To determine the amount of each payment that must be included in gross income, you need to figure out what portion of each payment represents a return of principal (which is not taxable) and what portion represents interest (which is taxable). In this case, since the annuity was purchased for $300,000 and will pay out a total of $480,000 over 10 years, the cost recovery ratio is 62.5% ($300,000 ÷ $480,000). This means that 62.5% of each payment is considered a return of principal and is not taxable, while the remaining 37.5% is considered interest and is taxable. Therefore, Fran must include $4,500 ($12,000 × 0.375) of each quarterly payment in her gross income.

Fran Purchased an Annuity That Provides $12,000 Quarterly Payments for the Next