QUESTION: According to an earlier "Jacobs" post, foreign variable
annuities are taxed as ordinary income, and can be classified as
miscellaneous income on the 1040. Therefore if the taxpayer is
living/working abroad and earns less than the FEI (foreign earned
income exclusion), the gains on the foreign variable annuity would get
a big tax break because the marginal tax rate could be very low. Is
my thinking right on this?

REPLY: The earlier post to which you refer is probably the one on Feb.
18th (# 556 - Tax on Swiss Annuity). In that memo, I stated that gains
in the cash value of a FIXED RETURN DEFERRED annuity are treated as
current income because of an IRS regulation (TD 8754, Reg. 1.1275) I
also stated that a VARIABLE annuity is not subject to this treatment
because it is not considered to be a debt instrument.

Regarding your assumption that a taxpayer who is taking advantage of
the FEI exclusion would be in a low tax bracket, that was true before
the Tax Increase Prevention and Reconciliation Act of 2005 [IRC Sec.
911(f)]. That law introduced a provision that taxes other income for
someone who utilizes the FEIE at the brackets that would apply if the
FEIE were not utilized. Thus, the tax rates on other income start at
the point where the earnings exclusion ends. The new rule is effective
for tax years beginning after 2005.

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

P.S. If you like the service, spread the word.