What amount of each monthly payment is taxable to Derrick, who is receiving $1,500 monthly from his annuity?

To determine how much of Derrick's monthly annuity payment is taxable, it’s essential to understand the tax implications of annuities. The taxation of annuity payments depends on a few factors including whether the annuity was purchased with after-tax money or pre-tax funds.

In the context of his payments, a portion is considered a return of his investment (the principal he contributed) and is not taxable, while the remainder is earnings (interest) which is taxable. Specifically, when an individual buys an annuity, they pay a certain amount which is known as their "cost basis." The earnings on those funds are subject to income tax upon distribution.

For example, if Derrick has a total cost basis of $8,000 in the annuity and is set to receive payments totaling $18,000 over the life of the contract, a calculation needs to be made to determine the taxable amount versus the nontaxable amount. The annuity payment can be taxed on a pro-rata basis.

If it is assumed that $1,125 of each payment represents his return of investment and $375 represents the taxable earnings, then the $375 of his payment is the amount that would be included in his taxable income. Thus, he would report $375