Question

Over the years, Luke paid $65,000 in premiums on a whole life policy with a surrender value of $200,000 and $500,000 death benefit. How much is taxable if upon reaching 65, Show and Label ALL work a) Luke passes away and $200,000 is paid to his sister b) Luke cashes the policy in while in good health c) Luke cashes in the policy after being diagnosed with a terminal illness with a life expectancy of 20 months

Answer 1

a. IRS in its frequently asked question clearly mentions that proceeds received upon death as beneficiary for life insurance policies are tax free and not included in gross taxable income. Hence, Nil tax

b. Section 61(a) provides that, except as otherwise provided in the income tax provisions of the Code, gross income includes all income from whatever source derived, including (but not limited to) income from life insurance contracts. See § 61(a)(10). To the extent that another section of the Code or regulations provides specific treatment of any item of income, that other provision applies notwithstanding § 61 and the regulations thereunder.

Hence, 20,000-65,000 =135,000 is included in gross taxable income

Less: standard deduction - (14,100)

Taxable income - 120,900

Taxes on income above $85,525 but not over $163,300 is $14,605.50 plus 24% of the excess over $85,525 i.e 14,605.5+8,490= $23,095.50

c. Accelerated death benefits are fully excludable if the insured is a terminally ill individual. This is a person who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months from the date of the certification.

Hence, in this case where life expectancy is 20 months is exclused from taxability and Nil tax shall be liable.