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The Taxation of Annuity Income and Debt Cancellation

1.Jane purchased an annuity contract that pays her $800 per month. The annuity cost her $60,000 and it has an expected return of $100,000. How much of each monthly annuity payment is includible in jane's gross income?

2. Sam owes Bob $8,000. Bob cancels (forgives) the debt. The cancellation is not a gift and Sam is bankrupt. Which of the following statements is correct concerning the impact of this transaction?

a. Both Bob and Sam recognize $8,000 of taxable income.
b. Bob recognizes $8,000 of taxable income.
c. Sam recognizes $8,000 of taxable income.
d. Neither Bob nor Sam has any taxable income from this transaction.

Solution Preview

1. A taxpayer will generally owe tax on the full amount of annuity proceeds he or she receives. However, it is a basic principle of taxation that one need not pay income on recovery of his or her original investment ("basis"). Because Jan contributed $60,000 and expects to receive total annuity proceeds ...

Solution Summary

This solution discusses the computation of the taxable portion of annuity income when the holder has invested in the annuity contract, as well as the taxability of the amount of debt forgiveness.