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 Dear Tax Talk:
I was paid a lump sum from my grandfather's annuity when he passed away. This amount had taxes taken out before I received the complete check. Do I report this as income on my taxes or is this considered an inheritance, which shouldn't affect my income for 2007?
-- Kristin
 Dear
Kristin,
The general rule is that inheritances are not considered income and do not affect your taxes in the year that you receive the inheritance. As in all general tax rules, and in the case of inheritances, the exception is income in respect of a decedent.
All income the decedent would have received had death not occurred that was not properly includible on the decedent's final income tax return is income in respect of a decedent. The most typical item of income in respect of a decedent is an inherited IRA. Other examples include wages unpaid at the time of death, savings bond interest, installment sale income and annuities.
In an annuity, an individual typically deposits money with an institution that agrees to pay that person a fixed or variable amount of money over a period of time. Each annuity payment represents the return of the original deposit plus the earnings on the deposited funds.
Because your grandfather bequeathed the annuity to you, it is your obligation to report this as income on your tax return. The amount that is income should be readily determinable by the payer and should be reported to you on a Form 1099-R. Box 7 of Form 1099-R should have a distribution code of 4, indicating that the amount was paid on account of death and that no early distribution penalty applies.
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