Penalties imposed by the insurance company should not be reported as distributed to the taxpayer - and therefore are not taxable - yes - the same way as fees.
On the form 1099-R distributed amount in the box 1 - should be reported after penalties are deducted - http://www.irs.gov/pub/irs-pdf/f1099r.pdf - please verify with the insurance company that the form filled correctly.
Yes, but is any portion tax deductible as a miscellaneous expense when itemizing Form 1040 expenses?
As that amount is not included into your income - it is not deductible.
You generally may deduct only out-of-pocket expenses.
Can the penalty be considered an out-of-pocket expense?
After all, a significant percent of my annuity is being withheld. It's certainly an out-of-pocket expense to me. Or is that thinking to logically for the IRS!
Can the penalty be considered an out-of-pocket expense? - yes - if that amount is included into taxable distribution on the form 1099-R.
Do you have a basis in the annuity? Did you contributed any after-tax money into the annuity? - if yes - did you fully recover your contribution? Or the distributed amount is less that whatever you put into the annuity?
No basis in the annuity.
No is the answer to all of the questions.
Guess, I'm just out of luck.
Most likely - yes - as none from contribution were previously included into your income - the full amount of distribution is taxable.
You might be able to deduct losses if the amount of distribution is less than the amount of contribution. If no - there is no looses.
As fees are paid from before tax funds - they are already excluded from taxable income - and you may not deduct them again.
Sorry if you expected a different answer.
Let me know if you need any help.
Tax Preparer
Taxes, Immigration, Labor Relations