The tax treatment depends on whether the annuity is qualified or non-qualified. For non-qualified annuities (funded with after-tax dollars), each payment consists of a taxable gain portion and a tax-free return-of-principal portion, calculated using the IRS exclusion ratio. For qualified annuities (funded through an IRA or 401(k)), the full payment is taxable as ordinary income. Consult a tax advisor for guidance specific to your situation.