Jerry purchased an annuity contract at the beginning of 2004 for $144,000. The contract specified that he and his wife would receive $1,000 per month for life. Jerry receives his first payment on February 1, 2018 when he is 59 years old and his wife is 56 years old. What amount of gross income should Jerry and his wife report on their 2018 income tax return from this annuity contract?
A)$-0-
B)$4,400
C)$6,600
D)$11,000

Question

Quizplus · Accepted Answer

To calculate the taxable portion of the annuity payment, Jerry and his wife need to use the exclusion ratio. The exclusion ratio is calculated by dividing the original investment ($144,000) by the expected return over the life of the annuity.

Assuming that Jerry and his wife will both live to their life expectancies, the expected return is 20 years (240 months) x $1,000 per month = $240,000.

Therefore, the exclusion ratio is $144,000 / $240,000 = 0.6. This means that 60% of each annuity payment is considered a tax-free return of principal, and 40% is taxable income.

In 2018, Jerry and his wife will receive 11 annuity payments (February through December). Each payment will be $1,000 x 0.4 taxable portion = $400.

So, the total taxable income from the annuity contract for 2018 is $400 x 11 payments = $4,400.

Therefore, the correct answer is choice C, $6,600.

Jerry Purchased an Annuity Contract at the Beginning of 2004