Question

Josh pays $120,000 for a single-life annuity that pays him $11,000 a year for life. Treasury Department tables estimate his expected remaining life at 15 years.

a. How much of each $11,000 payment must Charles report as gross income?

b. If Charles dies after receiving annuity payments totaling $77,000 over seven years, what happens to the unrecovered cost?

Please show all work. Will rate!

Answer 1

1. $3,000. If Josh lives for 15 years, he will receive a total of $165,000 (15 x $11,000). $120,000 of this represents a return of his investment; the remaining $45,000 represents income earned on this investment and is taxable. Of each $11,000 payment, $3,000 [($45,000/$165,000) x $11,000] must be included in income. The remaining $8,000 is a tax-free return of his investment.
2. If Josh dies after receiving only $77,000 (7 years at $11,000 per year), he will have recovered only $56,000 (7 x $8,000) of his total $120,000 investment. The remaining $64,000 ($120,000 - $56,000) can be deducted on his final tax return.