The taxable portion of each annuity payment is calculated using which method?

• A. Exclusion Ratio Method
• B. Straight-Line Depreciation Method
• C. Percentage-of-Completion Method
• D. LIFO (Last-In, First-Out) Method

Answer: (A)

Verified step by step guidance

1. Understand the concept of an annuity: An annuity is a series of equal payments made at regular intervals. For tax purposes, part of each annuity payment may be taxable, while the other part represents a return of the original investment (non-taxable).
2. Learn about the Exclusion Ratio Method: This method is used to determine the taxable and non-taxable portions of each annuity payment. The exclusion ratio is calculated as the investment in the contract (cost basis) divided by the expected total return (total payments expected over the annuity's life).
3. Set up the formula for the exclusion ratio: \( \text{Exclusion Ratio} = \frac{\text{Investment in Contract}}{\text{Expected Total Return}} \). This ratio helps identify the non-taxable portion of each payment.
4. Apply the exclusion ratio to each payment: Multiply the exclusion ratio by the amount of each annuity payment to determine the non-taxable portion. The remaining portion of the payment is taxable.
5. Compare with other methods: Understand that the other methods listed (Straight-Line Depreciation, Percentage-of-Completion, and LIFO) are not relevant for calculating the taxable portion of annuity payments. These methods are used for different accounting or tax purposes.