Question

Alice has a life insurance policy with a cash surrender value of $200,000 on which she has paid $30,000 in premiums. She has decided to cash in the policy. Discuss the tax consequences if Alice is terminally ill and decides to use the proceeds to take a cruise around the world.

a) She can exclude all of the gain in the policy ($200,000 less $30,000 of premiums paid) from gross income

b) She must include all of the gain ($170,000) in gross income

c) She must include all $200,000 received in gross income

d) She must include $30,000 in gross income

Answer 1

Option A) is correct : She can exclude all of the gain in the policy ( $ 200,000 less $ 30,000 of premium paid ) from gross income.

For general policy holder amount of surrender benefits over net premium paid is taxable and included in his or her gross income . But for terminally ill people such gain is not taxable and it is excluded from his/her gross income.

Option B is incorrect  : For terminally ill people the net surrender gain from life insurance policy is not taxable and it is excluded from his/ her gross income. So, it can't be included in her gross income.

Option C is also incorrect : Because her net gain is $ 170,000 so there is no question to include $ 200,000 in gross income.

Option D is also incorrect : $ 30,000 is the expenses of the policy holder for paying premium , it is not the gain amount.

Note : Terminally ill person is the individual who has been certified by registered medical officer , that the illness will never been overcome and with in 24 months the person will die.