How do structures avoid tax penalties for annuities not held by natural persons and premature distributions?
Section 72(u) of the code does indeed make income accrued or received each year on the contract taxable as ordinary income, if not owned by a natural person. This would be disastrous for the assignment company except for the fact of the exception in subsection (3)(C) when the annuity “is a qualified funding asset (as defined in section 130(d), but without regard to whether there is a qualified assignment.” Section 72(q) imposes a 10 percent penalty generally for distributions to taxpayers under age 59½ or unless the payments begin within a year and are substantially equal over the annuitant’s life expectancy. However, the same exception exists under subsection (2)(G) for a 130(d) qualified asset. The language of these exceptions allows the original defendant or liability insurer to own the annuity and avoid adverse tax consequences without making a qualified assignment, as long as all payments are excludible from income under IRC § 104(a)(1) or (2).
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