There continues to be uncertainty concerning the tax treatment of earnings distributed from a non-qualified individual annuity. This ambiguity extends to taxpayers, tax preparers, Illinois Department of Revenue (IDOR) representatives, and tax software companies. The non-qualified individual annuity discussed here is a tax-deferred-earnings plan purchased with after-tax dollars by an individual directly from an insurance company. It is not a deferred compensation or employer-based plan.
Section 203(a)(2)(F) of the Illinois Income Tax Act (IITA) defines the eligible subtraction of retirement income from AGI on the Illinois Form 1040 as follows:
An amount equal to all amounts included in such total pursuant to the provisions of Sections 402(a), 402(c), 403(a), 403(b), 406(a), 407(a), and 408 of the Internal Revenue Code, or included in such total as distributions under the provisions of any retirement or disability plan for employees of any governmental agency or unit, or retirement payments to retired partners, which payments are excluded in computing net earnings from self employment (sic) by Section 1402 of the Internal Revenue Code and regulations adopted pursuant thereto.
Why Non-qualified Individual Annuities Are Taxable
In a recent follow-up with IDOR’s management and legal staff, they clarified that the Internal Revenue Code provisions above refer to either qualified employer-based retirement plans or IRAs. Income that does not fall under one of these provisions does not qualify for subtraction. Non-qualified individual annuities are not eligible while annuities created within qualified plans (e.g. 403(b), IRA, etc.) are eligible for subtraction.
