496. What is the tax treatment of a partial 1035 exchange?Stevenrcline202012-09-06T16:34:00Z2015-04-28T20:16:00Z2015-04-28T20:16:00Z24562603Summit Business Media216305314Site Map/Annuities/Nonqualified/Disposition/Policy Exchanges1035 exchange Q30 302005-01-24T00:00:00ZTaxFactsDefaultArticleEthics and 1035 Exchanges.pdfSite Map/Annuities/Quick Clicks/1035 ExchangeEthics and 1035 Exchanges.pdf10030-00-TF1.xml30.00;#1589;#1592;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 1Does tax liability arise when a policyholder exchanges one annuity contract for another?
1285123600.000000000TaxFactsDefaultArticleSBMEDIA\cjump2010-06-04T10:54:51Z496. What is the tax treatment of a partial 1035 exchange of an annuity contract?The Tax Court, in Conway v. Commissioner,.111 TC 350 (1998), acq. 1999-2 CB xvi. held that a 1035 exchange occurred when the taxpayer transferred a portion (but not all) of the funds from one annuity to a second newly-issued annuity. The IRS later ruled that the proper way to allocate investment in the contract when one annuity is “split up” into two annuities is on a pro rata basis based on the cash surrender value of the annuity before and after the partial exchange. For example, if 60 percent of an annuity’s cash surrender value is transferred to a new annuity, the investment in the contract of the “new” annuity will be 60 percent of the investment in the contract of the “old” annuity, and the investment in the contract of the “old” annuity will be 40 percent of what it was before the partial exchange..Rev. Rul. 2003-76, 2003-33 CB 355.In 2008, the IRS released a revenue procedure concerning certain tax-free partial exchanges of annuity contracts (under Sections 1035 and 72(q)). The revenue procedure applies to the direct transfer of a portion of the cash surrender value of an existing annuity contract for a second annuity contract, regardless of whether the two annuity contracts are issued by the same or different companies.Under current law, a transfer will be treated as a partial tax-free exchange under Section 1035 under current final rules issued in 2008, as updated by Revenue Procedure 2011-38, as long as the taxpayer does not take any withdrawals from either contract within 180 days of the partial exchange. When a partial 1035 exchange is completed, the basis is divided pro rata between the old contract and the new one based on the relative value of the contracts when the split occurred. If the direct transfer of a portion of an annuity contract for a second annuity contract does not qualify as a tax–free exchange, it will generally be treated as a taxable distribution followed by a payment for the second contract, although the IRS reserves the right to conclude differently after applying general tax principles to determine the substance and appropriate treatment of the transfer. The IRS will not require aggregation of two annuity contracts that are the subject of a tax-free exchange (under Section 1035 and this guidance) even if both contracts were issued by the same insurance company..Rev. Proc. 2011-38, 2011-30 IRB, , superseding Notice 2003-51, 2003-33 CB 361. The exchange of nontransferable tax sheltered.IRC Section 403(b). annuity contracts is discussed in Q 3931.Planning Point: Although the rules under IRC Section 1035 cover a broader array of annuity exchanges, funds in nonqualified annuities are not freely movable. For example, the IRS does not provide guidance on the transfer of a portion of the funds in one annuity to a second existing annuity. It is not certain that such a transaction is covered under Section 1035 and therefore this type of transaction may not receive tax-free treatment. Fred Burkey, CLU, APA, The Union Central Life Insurance Company.