QUESTION: I have a Swiss Annuity. I paid my 1% tax on the Annuity on
the 720 Form. Now I understand, even if the assets are not sold, I
must pay tax each year on the increase in value. The money is now in
euro's. We have a profit. Where do I report capitol gain that
has not been sold but I am told it is taxable. I have not held it
for more than a year and do not know, at this time, if it will be
held for more than a year. (Alice)

REPLY: It's my understanding that Swiss annuities and life insurance
are exempt from the 1% premium tax because of the terms of the
U.S./Swiss tax treaty -- but I have not read the treaty myself to
verify that. I've searched on the Internet but the most recent treaty
that is available on the IRS web site is the 1996 treaty. However, if
there is an exemption from the 1% premium tax, the U.S. taxpayer would
be required to file a Form 8833 to explain the use of a treaty to
avoid a provision of U.S. law.

As for the treatment of accumulations of annuity cash values as
current income, that derives from a 1998 IRS regulation (TD 8754 -
Reg. 1.1275) that treats a fixed return deferred annuity as being
subject to what are called the "original issue discount" (OID) rules.
Those rules impose a current tax on accumulations of interest in a
deferred debt obligation. A fixed return annuity was held to be the
same as a deferred debt obligation. However, the regulation made an
exception for fixed return annuities that were "immediate" or in-pay
status. That means that the annuity amount is being distributed rather
than being accumulated. (An immediate annuity is one that will begin
payments to the annuitant within a year of making a deposit.) Variable
annuities are not deemed to be debt obligations of the insurance
company because the benefits are dependent on investment performance.

The income that must be reported for a foreign, fixed return, deferred
annuity contract is basically the increase in the cash value from year
to year. If the cash value is denominated in a foreign currency, such
as the Euro, then that value needs to be converted to dollars at the
end of each year. Any gain or loss arising from the currency exchange
should be included as ordinary income with the gain or loss in the
annuity cash value. It can either be reported as non-qualified
dividend income (taxed at ordinary rates) or it can be reported as
"other income" on the last line of the Form 1040 -- just before the
section dealing with adjustments to gross income.

The "more than one year" holding period for long term gains does not
apply to this type of income. It does not matter how long the contract
has been owned.

For further information on this subject see
http://www.offshorepress.com/offshoretax/otannuity.htm
and http://www.assetprotectioncorp.com/swissannuities.html
and http://www.swissprivacy.com/swiss_annuity.htm

The comments in this memorandum are not intended to constitute an
opinion regarding any specific tax issues because additional tax
issues may exist that could affect the tax treatment of the tax issues
addressed in this memo. This memorandum does not consider or reach a
conclusion with respect to those additional issues and was not written
and cannot be used for the purpose of avoiding penalties under code
section 6662(d). For further details see
http://www.offshorepress.com/vkjcpa/disclosurerules.htm

Vern

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