The IRS is reducing the period of time it will consider when reviewing a
partial exchange to 6 months, from 1 year.

The IRS made the change in Revenue
Procedure 2011-38, a document that also eases some other limits on partial
exchanges. The new revenue procedure, which amends Revenue Procedure 2008-24,
will be effective for exchanges completed on or after Oct. 24.

Ben Terner, managing director of the Einstein Group L.L.C., New York, a financial services consulting firm, says the revenue procedure applies primarily to exchanges in which cash value is involved.

Section 1035 of the Internal Revenue Code (IRC) gives a taxpayer the ability
to exchange one annuity for another without recognizing a taxable gain or
loss.

IRC Section 1035 recognizes that tax-free exchange treatment is appropriate
for “individuals who have merely exchanged one insurance policy for another
better suited to their needs,” according to Terner, who is a member of the panel
of experts at AdvisorFX and AdvisorFYI, Summit Business Media
publications,

In a partial exchange, an annuity holder moves a portion of the cash
surrender value of one annuity into an annuity issued by another company.

When the IRS issued the 2008 revenue procedure, it provided Section 1035
treatment for a partial exchange if no amount was withdrawn from, or received in
connection with the surrender of, either of the contracts involved in the
exchange during the year beginning on the date of transfer, or if the taxpayer
could show that one of a number of life-changing events listed in IRC Section
72(q)(2), or a similar life-changing event, such as divorce, had occurred.

The new procedure shortens the period under consideration to 180 days.

The 2008 procedure was changed because taxpayers who have reached the age of
59 ½, or are dying or disabled, have reported having difficulty with applying
the procedure, IRS officials say.

Taxpayers have complained, for example, that a 12-month waiting period is
administratively difficult, especially when an income tax return has already
been filed for the year an exchange took place.

Taxpayers also have complained that, under the 2008 procedure, it is unclear
how an exchange that does not qualify as tax-free should be characterized.

In the new, 2011 procedure, the IRS has eliminated a rule requiring that a
taxpayer involved in a tax-free partial annuity exchange become 59 ½, be dying
or disabled, or experience either one of the life-changing events listed in
Section 72(q) or a similar life event.

The new procedure also ends the limitation on amounts withdrawn from or
received under an annuity contract involved in a partial exchange if the amounts
received on an annuity occurred over a period of 10 years or more, or “during
one or more lives.”

The IRS has eliminated the automatic characterization of a transfer as either
a tax-free exchange under Section 1035 or a distribution taxable under Section
72(e) followed by a payment for a second contract.

The IRS says it will use “general tax principles” to determine how to
characterize a transfer.