If you receive payments as a survivor annuitant, when the first annuitant had reported the annuity under the Three-Year Rule, you include the total amount of the payment in your taxable income. If the first annuitant had been using the General Rule, you would continue to apply the same exclusion percentage to the payments you receive, and the resulting tax-free portion on that amount of a payment will then remain fixed. If there are subsequently any increases in the payments you receive as survivor, the additional amount would be fully taxable.
If the first annuitant used the Simplified Method to determine the tax-free and taxable portions of the payment, you as the survivor annuitant continue to use the same tax-free amount for the payments you receive.
Lump Sum Distributions
A lump sum distribution is a distribution of the entire balance in a certain type of plan, all at once. On Form 1099-R, the "Total distribution" box in 2b should be checked. A distribution of the entire balance from an unqualified account, such as a commercial annuity you purchase yourself, or a Section 457 deferred compensation plan, does not qualify for the special tax treatment of lump sum distributions.
There are optional methods of calculating the tax on lump sum distributions from a qualified employee plan or a qualified employee annuity, if the participant was born before January 2, 1936.
1. The part of the distribution that corresponds to participation before 1974 can be treated as a capital gain subject to a 20% tax. The part of the distribution for participation from 1974 on, would be taxed as ordinary income.
2. You can report the part of the distribution for participation before 1974 as capital gain and use the 10-year tax option to figure the tax on the part for participation from 1974 on.
3. You can use the 10-year option to determine the tax on the entire amount of the distribution.
4. You can roll over part or all of the distribution. You would not be subject to tax this year on the part you roll over.
5. Or you can report the entire distribution as ordinary income.
To use these optional methods, you will need to file Form 4972, Tax on Lump-Sum Distributions. If you choose the capital gain treatment, you would complete Part II of Form 4972. If you choose the 10-year tax option, you would complete Part III.
The 10-year tax option is a special formula used to calculate the tax on the ordinary income portion of the lump sum distribution. The tax resulting from this calculation is paid in the current year and not over 10 years. The 10 years refer to the nature of the calculation and not to the payment of the tax.