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Q. Is the loss on a Variable Annuity deductible?

Posted by: Pearl R.
A. You might think that this would be treated as a capital loss, to be reported on Schedule D with other investment losses, but that's not quite the case. Annuity losses are ordinary losses. There is little guidance from the IRS regarding losses on annuities. Recently, the IRS added a sentence in Publication 575, Pension and Annuity Income, page 20, that address this. First, you must cash out or otherwise surrender the entire contract to realize and deduct the loss on a non-qualified deferred annuity. You then can claim it as a miscellaneous itemized deduction on Schedule A. But that schedule allows you to deduct only the portion of the loss that exceeds 2% of your adjusted gross income (AGI). If you exchange your current annuity for another one using the provisions found in Code Section 1035, any gain or loss on the prior annuity will simply follow you into the new one, and you'll have neither income nor deductions to report on the exchange. And, it can get worse. Miscellaneous itemized deductions subject to the 2% floor are added back to gross income to determine Alternative Minimum Tax (AMT). So claiming the loss as a miscellaneous itemized deduction is a tough route no matter what. And if you don't itemize deductions, you'll be subject to the 2% hit and the standard deduction. This can be very confusing. It may be wise to consult a professional tax practitioner before making any financial decisions.