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If you withdrew $77,805.10 then it would all be taxable in the year of withdrawal if all of your IRA contributions were deducted when you made them. If you had made nondeductible IRA contributions then those amounts would be recovered tax-free. If you did make nondeductible contributions then you should have filed form 8606 in the years that those contributions were made.
If you only withdrew $35,000 and the balance remains in the IRA then only $35,000 should be taxable. You would have received a 1099-R in early 2008 with the amount of the distribution. So if the IRS is stating that $77,805.10 is taxable, then they must have received a 1099-R showing that amount. If you didn't receive that amount, then you should contact the annuity company to have a corrected 1099-R issued or a letter of correction.
no roll over from another account...... by already taxed money I just meant that this particular annuity was purchased with money saved, from payroll income that I had already paid taxes on.
So, I'am looking at this as ( round figures ) .....I earn $100,000.00, pay my taxes and wind up with $ 70,000.00 ...... use all this to buy annuity........cash in annuity...... and owe taxes again on the $ 70,000.00. ...hard pill to swallow.
If you had already paid taxes on the funds, then they were not permitted to be rolled over to an IRA in 1999 (they would be permitted to be rolled over now as the law was changed). The rollover would have been considered an excess contribution rollover and subject to a 6% penalty every year it remained in the IRA ($4,200 a year). If you were advised to do this by a financial consultant, then he/she may have been negligent depending on the circumstances and you may be able to obtain a settlement from his/her firm for such action if you have sufficient documentation proving this.
If your payroll deductions were contributed to either a 403(b), 401(k), or 457(b) plan by your employer then they would have been pre-tax contributions.