Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 72-193

1972-1 C.B. 58

Sec. 72
Sec. 165

IRS Headnote

The administrator of an estate may not deduct as a loss on the decedent's final tax return the excess of the cost of a nonrefund life annuity contract over the aggregate amount received tax-free during the decedent's lifetime; I.T. 2915 superseded and Revenue Ruling 61-201 distinguished.

Full Text

Rev. Rul. 72-193 /1/

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in I.T. 2915, C.B. XIV-2, 98 (1935).

The question presented is whether the administrator of the estate of A may deduct as a loss, under section 165(c)(2) of the Internal Revenue Code of 1954, in the 1968 Federal individual income tax return filed in behalf of the decedent who died in 1968, the excess of the cost of a nonrefund life annuity contract purchased by A in 1966 over the aggregate amount of payments received tax-free by A under such contract during his lifetime.

The nonrefund life annuity contract was purchased by A in 1966 at a cost of 150x dollars, which amount was paid in full in that year. Under the provisions of the contract, payments in the amount of x dollars per month were received by the annuitant until the date of his death, the aggregate of such payments being 24x dollars, 6x dollars of which was received in 1968. No other amounts were received under the contract and the contract did not provide for any payments to be made to A's estate or a beneficiary in the event that the obligation to make payments should cease by reason of his death prior to his receipt of a specified total of annuity payments.

Under section 1.72-4 and related Income Tax Regulations pertaining to section 72 of the Code, an exclusion ratio based on an expected return under the contract of 180x dollars had been determined and applied to the 18x dollars received in A's taxable years prior to 1968 to ascertain the proportionate part of the total amount received each year as an annuity that was excludable from A's gross income in the taxable year of receipt. This resulted in the sum of 15x dollars of the total of 18x dollars that A received under the contract prior to 1968 being excluded from his gross income under the law applicable at the time of receipt. For the year 1968, application of the exclusion ratio resulted in 5x dollars of the 6x dollars received being excludable. Hence, for the period before the annuitant's death 20x dollars of the total of 24x dollars received by A was excludable from A's gross income, while 4x dollars was includible. It follows that A had an unrecovered basis of 130x dollars at the date of his death.

Since the annuity was not refundable, no part of the 130x dollar basis at date of death was recoverable by or on behalf of the annuitant. The administrator therefore asks whether a loss in this amount may be claimed as a deduction under section 165(c)(2) on the final return filed by the administrator for A.

Section 165(c)(2) of the Code provides, in pertinent part, that in the case of an individual, there shall be allowed as a deduction any loss sustained during the taxable year in any transaction entered into for profit.

Whether a transaction was entered into for profit depends upon the particular facts in each case. Under circumstances similar to those presented in this case, the Circuit Court of Appeals for the First Circuit found that no deductible loss was sustained by an annuitant who died before receiving in annuity payments a return of his entire investment in the annuity contract where, as in the instant case, the annuitant purchased a single premium nonrefund annuity policy under the terms of which he was to receive monthly payments of a specified amount for the remainder of his life. Industrial Trust Co. v. Joseph V. Broderick, 94 F. 2d 927 (1938), certiorari denied, 304 U.S. 572 (1938). This decision was based on the court's determination that the annuitant did not enter into the contract for profit; that he was rather seeking security during the term of his life and had experienced no deductible loss from full performance of the terms of the contract.

This decision also discusses the case of George M. Cohan v. Commissioner, 11 B.T.A. 743 (1928), wherein a loss deduction was allowed for forfeited premium payments made on annuity contracts involving certain guarantees, and distinguishes that decision on grounds that there was strong evidence in the Cohan case that the amounts paid for the annuities involved were not expended "for security" but for profit, inasmuch as the right of the contracts was forfeited when the terms thereof were reconsidered and found unprofitable.

The Industrial Trust Co. case was later cited in Estate of N. B. Early v. James J. Atkinson, 175 F. 2d 118 (1949), a case wherein the court commented as follows:

The decisions, in which the gain or loss involved in annuity contracts is considered, for the most part take the view that when the clear purpose is manifest to safeguard the interest of the assured by providing a fixed annual income, the mere fact that the amount received is less than the premiums paid does not of itself constitute a deductible loss. Nor does the mere possibility that a profit may be incidentally involved indicate that the transaction was 'entered into for profit.' * * *

(This quotation has been set forth in support of the more recent decision in the case of Arthur F. Arnold v. United States, 180 F. Supp. 746 (1959).)

In the instant case the claimed loss arises not from the surrender of a refund annuity contract for a cash consideration, nor from a forfeiture (as was true in the Cohan case), but from the termination of the insurer's obligation to make annuity payments under the terms of the contract upon the death of A at a time when A had received annuity payments aggregating less than the amount he paid for the contract.

From all the circumstances of this case, it appears that A's primary purpose in entering into the contract was to provide security for himself, should he continue to live, in the form of a fixed monthly income. He received what he contracted for, although less than he hoped for or anticipated. The fact that a loss arose solely and directly from the performance of the contract in accordance with its terms does not tend to show that the taxpayer entered the transaction primarily for profit. Hence, while the taxpayer actually received far less by way of payments made pursuant to the contract than the total amount he paid for the annuity, he nevertheless did not suffer a loss deductible under section 165(c)(2) of the Code.

Accordingly, it is held that no loss deduction is allowable to the administrator of the estate of A upon his filing the final Federal individual income tax return on behalf of the decedent for the excess of the cost of the annuity over the amounts received prior to A's death that were properly excludable from his gross income under the law applicable at the time of receipt.

The facts in the instant case are distinguishable from those involved in Revenue Ruling 61-201, C.B. 1961-2, 46, which holds that the original purchaser of a single premium refund annuity contract who surrendered it for a cash consideration sustained an ordinary loss to the extent that the basis of the contract (the basis being its cost less the amounts previously received under the contract that were properly excluded from the gross income of the recipient under the law applicable at the time of receipt) exceeded the amount received upon surrender. Revenue Ruling 61-201 concludes with the statement that nothing in it should be construed as permitting a deduction on the surrender of any contract other than a refund annuity. The instant case is distinguishable from that in Revenue Ruling 61-201 because neither a refund annuity nor its surrender is involved here.

Revenue Ruling 61-201, is distinguished.

I.T. 2915 is superseded, since the position set forth therein is restated under current law in this Revenue Ruling.

/1/ Prepared pursuant to Rev. Proc. 67-6, C.B. 1967-1, 576.