10 life insurance tax facts you should know



1. Are life insurance proceeds payable on the basis of the taxable income of the insured to the beneficiary?


In general, no. As a general rule, the death benefit is excluded from the gross income of the beneficiary. The death proceeds of single premium, periodic premium or flexible premium policies are received tax-free by the beneficiary, whether they are an individual, a corporation, a partnership, a trustee or the estate of the beneficiary. ‘assured. With a few exceptions (as noted below), the exclusion generally applies regardless of who paid the premiums or who owned the policy.

Please note that death proceeds from certain employer-owned life insurance policies received by the employer as a beneficiary will not be excluded from the employer’s taxable income unless certain conditions are met. Group life insurance proceeds may be eligible for exclusion as well as individual policy proceeds

2. If a taxpayer gives a spouse a life insurance policy, is the taxpayer entitled to a deduction for spousal gift tax?

Yes. An outright donation of a life insurance policy to the donor’s spouse gives the right to the deduction of gift tax in the same way as the donation of a bond or any other similar property. The same applies to subsequent premiums paid on the policy by the donor. An annual exclusion may be allowed in place of the marriage deduction if the recipient spouse is not a U.S. citizen.

3. Are dividends payable on a participating life insurance policy taxable income?

As a general rule, all dividends paid or credited before a contract expires or surrenders are exempt from tax as a return on investment until an amount equal to the policyholder’s base has been paid. recovered. Specifically, when the cumulative dividends plus all other amounts received tax-free under the contract exceed the cumulative gross premiums, the excess constitutes taxable income. It doesn’t matter whether dividends are taken in cash, applied to current premiums, used to buy paid-up additions, or left with the insurance company to earn interest.

Thus, accrued dividends are not taxable either currently or at the time of withdrawal (but interest on accrued dividends is taxable) until the accumulated dividends plus all other amounts received tax-free under the contract exceed the cumulative gross premiums. At this point, the excess is taxable income.

4. What are the tax results when life insurance or endowment dividends are used to purchase paid-up insurance add-ons?

Normally, no tax will arise at any time when life insurance or endowment dividends are used to purchase paid-up insurance add-ons. Dividends not exceeding the investment in the contract are not taxable income, the annual increase in the cash value of the paid-in additions is not taxed on the policyholder and the proceeds of death are free of charge. tax. This is because dividends reduce the base cost of the initial amount of insurance and constitute the cost of the additions released. Therefore, on maturity, sale or surrender during the life of an insured, gross premiums, including the cost of paid-up additions, are used as the cost of insurance in the calculation of the gain on the total amount of the proceeds, including the proceeds of additions.

5. If accumulated or post-mortem life insurance dividends are received by the beneficiary of a deceased insured, are they taxable income for the beneficiary?

No. Accumulated dividends are exempt as property received by inheritance. Terminal and post-mortem dividends are exempt as amounts received under a life insurance contract and paid due to the death of the insured. In addition, it appears that accrued interest, if it was implicitly received by a policyholder in a prior year, is not taxable for a beneficiary even if the policyholder failed to report the amounts. interests.

6. What is the tax treatment of an amount received from a viatic settlement provider?

If a portion of a death benefit under a life insurance policy on the life of a terminally ill or chronically ill insured is sold or assigned to a viatic settlement provider, the amount paid for the sale or assignment will be treated as an amount paid under the life insurance contract insurance due to the death of the insured. In other words, such an amount will not be included in income.

7. Are there any exceptions to the general rule that viatic settlements are not included in taxable income?

There is an exception to this general rule of non-inclusion for Asian settlements. The rules described above do not apply to amounts paid to a taxpayer other than the insured if the taxpayer has an insurable interest in the life of the insured because the insured is a director, officer or employee. of the taxpayer or if the insured is financially interested in any business or business of the taxpayer.

8. Can a taxpayer deduct the interest paid on a loan to buy or take out a life insurance, capitalization or annuity contract?

Interest paid or accrued on debts contracted to purchase or maintain in force a life insurance, endowment or single premium annuity contract taken out after March 1, 1954, are not deductible. To this end, a single premium contract is defined as a contract in which substantially all of the premiums are paid within four years of the date of purchase, or on which an amount is deposited with the insurer for payment of ‘a substantial number of future premiums. When a single premium annuity is used as collateral to secure or maintain a mortgage, the IRS has found that IRC section 264 (a) (2) rejects the attributable amount of mortgage interest to the extent that the mortgage is secured by the annuity.

9. What are the tax consequences of leaving the life insurance cash values ​​or endowment product to the insurer under the interest only option?

Interest is fully taxable to the beneficiary as it is received or credited. In certain circumstances, the election of the interest option will defer tax on the proceeds. If the option is chosen before maturity or redemption without reservation of the right to withdraw the product, the product is not implicitly received in the year of maturity or redemption.

But if the right of withdrawal is retained, the IRS apparently views the product as received constructively when it first becomes withdrawable. (It can be argued, however, that the proceeds are not received implicitly when the policyholder has the contractual right to switch to another option.) If the option is chosen on or after the maturity or surrender date, the proceeds are received implicitly in the year of maturity or redemption.

10. If the life insurance proceeds are payable to a religious, charitable or educational organization, are their value taxable in the gross estate of the insured?

In general, no. If the insured has a property incident in the policy at the time of death, the proceeds are included in the insured’s gross estate, but a charitable deduction is allowed for their full value. If, however, the law of the state of the donor’s domicile does not recognize that a charity has an insurable interest in the donor’s life, complications can arise. In some states, a charity may not have an insurable interest in a newly issued insurance policy given to the charity or a policy applied for and issued to the charity as owner and beneficiary. If the charity has no insurable interest and the insurer or the insured’s estate raises the issue of no insurable interest, the insured’s estate may be able to recover the product (or premiums paid).

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