April owned an annuity contract (cash balance of $250,000) issued by Teal Insurance Company. She decides to switch to an annuity contract issued by Brown Insurance Company. To make the change, April instructed Teal to cash out her annuity by issuing a check to Brown. Teal refused to do so and issued a check for $250,000 payable to April.
April intended that the exchange of annuity contracts qualify for tax deferral treatment under § 1035(a)(3). Consequently, rather than depositing or cashing the check from Teal, she endorsed it and sent it to Brown. On audit, an IRS agent contends that the transaction does not qualify under § 1035(a) (3). For tax deferral to apply, the initial annuity contract must be directly exchanged for the new annuity contract. Evaluate the positions of the parties.