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annuity to be included in gross income. Section 72(b)(1)
excludes from gross income “that part of any amount received as
an annuity * * * which bears the same ratio to such amount as the
investment in the contract (as of the annuity starting date)
bears to the expected return under the contract (as of such
date).” As mentioned above, petitioner’s investment in the
contract was $71,244.41.5 His annuity starting date was February
1, 1996, the date on which he received his first payment from the
plan. See sec. 72(c)(4).
Under section 72(c)(3), employers can determine the expected
return under the contract by reference to actuarial tables.
Alternatively, they can use a simplified “safe-harbor” method,
under which “Investment/Number of Monthly Payments = Tax free
portion of monthly annuity”. See Notice 88-118, 1988-2 C.B. 450,
451.6 For distributees aged 56 to 60 on the annuity starting
date, the total number of monthly payments is 260. Id.
Ms. Wong testified that the city and county followed
precisely the method set forth in Notice 88-118, supra to
5 Petitioner testified that he contributed $137,293.29 to
the plan. The plan’s records show, however, that petitioner
contributed only $71,244.41. The remaining $66,048.88 of his
retirement account balance represented accumulated interest,
which is not part of his investment in the contract. See sec.
72(c)(1); Newman v. Commissioner, 68 T.C. 433 (1977).
6 Notice 88-118, 1988-2 C.B. 450, was replaced by Notice
98-2, 1998-1 C.B. 266, which applies to annuities with an annuity
starting date after Nov. 18, 1996. Because petitioner’s annuity
starting date was Feb. 1, 1996, Notice 88-118, supra controls.
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