Taxation of installment Option/Annuities

Question 1

Exclusion/Inclusion Ratio

Answer 1

(Basis / Total Payments) = Exclusion Ratio

Total Payments = Monthly payment x 12 months x life expectancy

Exclusion ratio x Monthly payments = Amount Excluded from income

Question 2

Buy annuity for $500k, will get $4,000/month for life, which is expected to be 20 years. How much of the monthly income is excluded and included in taxable income?

Answer 2

$4,000 x 12 x 20yrs = $960k total expected payments

Basis= $500k.
$500k /$960k= 52% exclusion ratio

$4,000 x 0.52 = $2,080 return of basis

$4,000 x 0.48 = $1,920 taxable as income