What is the primary focus when determining the taxable portion of annuity payments?

The taxable portion of annuity payments is primarily focused on the expected return over the life of the annuity. This concept is rooted in the principle that annuity payments consist of both a return of principal and earnings. The expected return is calculated based on the taxpayer's life expectancy and the total amount invested in the annuity.

When a taxpayer begins to receive annuity payments, a portion of each payment is considered a return of the investment (the basis in the annuity), and the remainder is regarded as taxable income. The challenge lies in determining how much of each payment is taxable based on the expected return, rather than just the contributions made or other factors. This ensures that taxpayers are not taxed on the return of their principal but only on the earnings generated by the annuity.

By focusing on the expected return over the life of the annuity, tax law provides a clear method for calculating the taxable portion of annuity income, which aligns with the idea that taxation should pertain to income or profit rather than a mere return of contributions.