FAQ’s from Tax Facts on Life and Health Insurance

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LIFE INSURANCE

In General

  1. What is life insurance?

Premiums

  1. Are premiums paid on personal life insurance deductible for income tax purposes?

  2. Can a taxpayer deduct interest paid on a loan to purchase or carry a life insurance, endowment, or annuity contract?

  3. Is the interest increment earned on prepaid life insurance premiums taxable income?

Cash Value Increases

  1. Are annual increases in the cash surrender value of a life insurance policy taxable income to the policyholder?

  2. Is the owner of a limited-pay life insurance policy liable for any tax when the policy becomes paid-up?

Living Proceeds

  1. What are the rules for taxing living proceeds received under life insurance policies and endowment contracts?

  2. How are distributions from a life insurance policy that is classified as a modified endowment contract (“MEC”) taxed?

Interest-Only Options

  1. What are the tax consequences of leaving life insurance cash surrender values or endowment maturity proceeds with the insurer under the interest-only option?

Dividends

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

  2. Is interest earned on life insurance dividend accumulations currently taxable to the policyholder?

  3. What is the tax treatment of life insurance dividends where endowment maturity values or cash surrender values are paid in installments or as a life income?

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

  5. Are dividends that are credited to a paid-up life insurance or endowment policy taxable income?

  6. If accumulated or post-mortem life insurance dividends are received by a deceased insured’s beneficiary, are they taxable income to the beneficiary?

  7. Where life insurance death proceeds are held under a settlement option, are excess interest dividends taxable to the beneficiary?

Policy Loans

  1. Are life insurance policy loans taxable?

  2. Can a life insurance policy owner take an income tax deduction for the interest he or she pays on a policy loan?

  3. If the beneficiary of life insurance pays the interest on a policy loan, is this a gift to the insured?

Disposition: Sale or Purchase of a Contract

  1. What are the income tax consequences to the owner of a life insurance or endowment contract who sells the contract, such as in a life settlement?

  2. How is the purchaser of a life insurance or endowment contract taxed?

Disposition: Policy Exchanges

  1. Does tax liability arise when a policyholder exchanges one life insurance contract for another one?

Disposition: Surrender, Redemption, or Maturity

  1. What are the income tax results when the owner of a life insurance or endowment contract takes the lifetime maturity proceeds or cash surrender value in a one sum cash payment?

  2. If a life insurance policyholder elects to receive endowment maturity proceeds or cash surrender values under a life income or installment option, is the gain on the policy taxable to the policyholder in the year of maturity or in the year of surrender?

  3. Can tax on the gain at maturity of an endowment contract be postponed?

Accelerated Death Benefit

  1. What is the income tax treatment of an accelerated death benefit payment from a life insurance contract?

Viatical Settlement

  1. What is the income tax treatment of an amount received from a viatical settlement provider?

Withholding

  1. Are amounts received as living proceeds of life insurance and endowment contracts subject to withholding?

Loss

  1. Does the surrender or sale of a life insurance or endowment contract ever result in a deductible loss?

Death Proceeds

In General

  1. Are life insurance proceeds payable by reason of the insured’s death taxable income to the beneficiary?

  2. Is the death benefit under the double indemnity clause of a life insurance policy subject to federal income tax?

  3. What is a “life insurance contract” for purposes of the death benefit exclusion?

  4. How are proceeds taxed if a life insurance policy is owned by someone other than the insured?

Interest Option

  1. If life insurance death proceeds are left on deposit with the insurance company under an interest-only option, is the interest taxable income to the beneficiary?

Life Income and Installment Options

  1. If excludable death proceeds are held by an insurer and are paid under a life income or installment option, how are the payments treated for income tax purposes?

Transferred Policy

  1. Are death proceeds wholly tax-exempt if an existing life insurance policy is sold or otherwise transferred for valuable consideration?

  2. Are death proceeds of life insurance wholly tax-exempt if the policy has been transferred as a gift?

  3. Will the transfer of a life insurance policy between spouses result in loss of the tax exemption for the death proceeds?

Estate Tax Issues

  1. What benefits payable at death are included in the term “life insurance” for estate tax purposes?

  2. When are death proceeds of life insurance includable in an insured’s gross estate?

  3. If life insurance proceeds are payable to an insured’s estate, is their value includable in the insured’s estate?

  4. When are life insurance proceeds includable in an insured’s gross estate even though the insured has no incident of ownership in the policy and the proceeds are not payable to the insured’s estate?

  5. Is life insurance that is taken out to pay an insured’s death taxes includable in the insured’s estate?

  6. When are life insurance proceeds that are payable to a beneficiary other than the insured’s estate includable in the insured’s estate?

  7. What are the incidents of ownership that, if held by an insured, will cause life insurance proceeds to be includable in the insured’s estate?

  8. If an insured holds incidents of ownership at death as a fiduciary or by reason of a retained right to remove a trustee and appoint another, will the life insurance proceeds be includable in the insured’s estate?

  9. Are life insurance proceeds includable in the insured’s estate if someone other than the insured took out the policy and owns it at the insured’s death?

  10. Can an insured remove existing life insurance from his or her gross estate by an absolute assignment of the policy?

  11. Are the general rules for including life insurance proceeds in the insured’s gross estate applicable to proceeds payable under a qualified pension or profit-sharing plan?

  12. May a life insurance beneficiary be required to pay estate tax attributable to death proceeds?

  13. May a life insurance beneficiary make a qualified disclaimer of an amount equal to the beneficiary’s proportionate share of death taxes when the decedent directed that death taxes be paid entirely out of the probate estate?

  14. When are death proceeds of life insurance given away by an insured within three years of the insured’s death includable in the insured’s gross estate?

  15. If a donor dies within three years of making a gift of a life insurance policy the donor owned on the life of another, is the value of the policy includable in the donor’s gross estate?

  16. If an employer provides, under a nonqualified agreement or plan, an income benefit only for certain survivors designated by family or marital relationship to the employee, how is the benefit treated for estate tax purposes in the employee’s estate?

  17. Is the value of a survivor benefit payable by an employer under a nonqualified salary continuation or deferred compensation agreement includable in the employee’s gross estate?

Generation-Skipping Transfer Tax Issues

  1. Can arrangements for payment of the proceeds of life insurance and annuity contracts attract the generation-skipping transfer tax?

  2. Can the transfer to an irrevocable life insurance trust of an amount used to make premium payments qualify for the generation-skipping transfer tax annual exclusion?

  3. How can the generation-skipping transfer (“GST”) tax exemption be leveraged using an irrevocable life insurance trust?

Divorce

  1. What are the income tax results where an individual transfers an existing life insurance policy to or purchases a policy for the individual’s former spouse in connection with a divorce settlement?

  2. If an individual is required by a court decree or separation agreement to pay premiums on a life insurance policy for a former spouse, are the premiums taxable income to the recipient spouse? Are they deductible by the payor spouse?

Estate Tax Issues

  1. If life insurance proceeds are required under terms of a property settlement agreement or a divorce decree to be paid to certain beneficiaries, are the proceeds includable in the insured’s estate? Is an offsetting deduction allowable?

Gifts and Charitable Gifts

  1. If a taxpayer gives a spouse a life insurance policy, is the taxpayer entitled to a gift tax marital deduction?

  2. If a primary beneficiary of life insurance proceeds payable under a settlement option has the power to withdraw part of the proceeds, does the beneficiary’s failure to exercise the power constitute a taxable gift to contingent beneficiaries?

  3. How are split dollar life insurance arrangements treated for gift tax purposes?

  4. What is the advantage of the “split-gift” law where either a husband or wife gives a life insurance, endowment, or annuity contract to a third person?

  5. Does an employee covered under a survivor income benefit plan make a gift of the survivor benefit for federal gift tax purposes?

  6. How are life insurance policies and endowment contracts valued for gift tax purposes?

  7. May a charitable contribution deduction be taken for the gift of a life insurance policy or premium? May a charitable contribution deduction be taken for the gift of a maturing annuity or endowment contract?

  8. May a charitable contribution deduction be taken for a gift of an interest in a split dollar arrangement?

  9. May a charitable contribution deduction be taken for a gift of a life insurance policy if the donor retains a right, shared with the donee charity, to change charitable beneficiaries?

  10. May a charitable contribution deduction be taken for a gift of the annuity portion of a split life contract?

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

  12. Are gifts of life insurance to charitable organizations subject to gift tax?

Single Premium Whole Life Insurance Policy

  1. How are single premium life insurance policies, including single premium variable life insurance policies, taxed?

Creditor Insurance

  1. If a debtor pays premiums on a life insurance policy on his or her life in favor of his or her creditor, may the debtor take an income tax deduction for these premium payments?

  2. Can a creditor deduct premiums paid on life insurance purchased on the life of the creditor’s debtor?

  3. If a creditor pays premiums on a life insurance policy held as collateral for a business debt, can the creditor claim an income tax deduction for the premium payments?

  4. If a creditor pays premiums on a life insurance policy securing a non-business debt, can the creditor deduct the premium payments?

  5. If a stockholder’s personal life insurance is used as collateral security for the corporation’s debt, are the premiums deductible?

Bad Debt Deduction

  1. May a creditor take a bad debt deduction for a worthless debt even though the creditor holds an insurance policy on the life of the debtor as collateral?

Proceeds

  1. Are proceeds received by a creditor from insurance purchased on the life of the creditor’s debtor exempt from income tax as life insurance proceeds?

  2. Are life insurance proceeds received by a creditor as collateral assignee or beneficiary “as interest appears” exempt from income tax?

Estate Tax

  1. If an insured assigns a life insurance policy as collateral for a loan, are the proceeds includable in the insured’s gross estate?

  2. If an insured assigns a life insurance policy where his or her spouse is the named beneficiary, will the full amount of the proceeds qualify for the marital deduction?

Government Life Insurance

  1. Are proceeds of government life insurance exempt from income tax?

Taxation of Distribution of Life Insurance Contract

  1. If a qualified plan trust distributes a life insurance policy to an employee, is the value of the contract taxable to the employee in the year of distribution?

Collection of Delinquent Income Taxes from Life Insurance

  1. Can the federal government reach the cash value of a taxpayer’s life insurance for collection of back income taxes?

  2. Can the federal government collect an insured’s delinquent income taxes from a beneficiary who receives life insurance death proceeds?

Policies Insuring More Than One Life

  1. Does the income taxation of a life insurance policy that insures more than one life differ from the taxation of a policy that insures a single life?

Value of Unmatured Policy

  1. How is the value of a life insurance policy determined for income tax purposes?

Demutualization

  1. What is the tax treatment when shares of stock received in a demutualization are sold?

Life Insurance Trusts

  1. When will a life insurance trust result in income tax savings for the grantor?

  2. If income of an irrevocable funded life insurance trust is used to pay premiums on a policy insuring the grantor’s life, is the income that is used taxable to the grantor?

  3. Can a grantor create an irrevocable funded life insurance trust, carrying insurance on the grantor’s spouse, without being taxed on trust income used for premium payments?

  4. When is life insurance trust income taxable to some person other than the trust, grantor, or income beneficiary?

  5. What income is taxable to a life insurance trust? What income is taxable to trust beneficiaries?

  6. May the grantor of a life insurance trust take a deduction for interest paid by the trust on a policy loan where the policy is held by the trust?

  7. Are death proceeds of life insurance taxable income if they are payable to a trust?

Gift Tax

  1. Is there a gift for gift tax purposes when a grantor transfers a life insurance policy to an irrevocable trust in which the grantor has no interest?

  2. If income-producing property is transferred to an irrevocable life insurance trust to fund premium payments, does the value of the property constitute a gift?

  3. How is the gift tax value of a “reversionary interest trust” measured?

  4. Does the transfer of a life insurance policy to an irrevocable trust for the benefit of the grantor’s spouse qualify for the gift tax marital deduction?

  5. If a grantor creates a revocable trust with a life insurance policy on the life of another person and names third parties as trust beneficiaries, does a gift take place when the insured dies and the trust becomes irrevocable?

  6. Does the gift of a life insurance policy in trust (or a gift of subsequent premiums) qualify for the gift tax annual exclusion?

  7. Is the annual exclusion available when a life insurance policy is placed in an irrevocable trust for a minor beneficiary?

  8. Do transfers to a trustee of an irrevocable life insurance trust of amounts to be used by the trustee to pay premiums qualify for the gift tax annual exclusion?

  9. If the beneficiary of a Crummey trust allows the right to withdraw a contribution to the trust to go unexercised, when will the beneficiary be deemed to have made a transfer subject to gift or estate tax?

  10. May dividends paid on a life insurance policy in trust be gifts of a present interest even though the policy itself was a gift of a future interest?

Life Insurance: Estate Tax Issues

  1. When can a beneficiary of life insurance proceeds be held liable for payment of federal estate tax falling on the insured’s estate?

Community (Marital) Property

  1. How are proceeds of community property life insurance treated in the insured’s estate?

  2. Where life insurance on the life of a spouse is bought with community funds and one of the spouses is designated policy owner, is the policy community property or is it the separate property of the spouse designated as the owner?

  3. What are the estate tax results in the insured’s estate where life insurance premiums have been paid with both community and separate funds?

  4. When can death proceeds of community property life insurance payable to someone other than the surviving spouse be includable in the surviving spouse’s gross estate?

  5. How is community property life insurance taxed where the spouse who is not the insured dies first?

Dividends

  1. How are life insurance paid-up additions purchased with dividends treated for estate tax purposes?

  2. What rules are applicable to including life insurance accumulated and post-mortem dividends in an insured’s estate?

Double Indemnity

  1. Are life insurance proceeds paid under a double indemnity clause includable in an insured’s gross estate?

Government Life Insurance

  1. Are proceeds of life insurance issued under U.S. government programs includable in the insured’s estate?

Group Life Insurance

  1. Are the proceeds of group term life insurance includable in an insured’s estate?

Life Insurance Trusts

  1. If a grantor creates a revocable life insurance trust with a policy on the grantor’s life, will the proceeds be includable in his or her estate?

  2. If policies on an insured’s life are placed in an irrevocable life insurance trust, are the proceeds includable in his estate?

  3. When are death proceeds includable in the estate of a life income beneficiary of a life insurance trust?

  4. If an income beneficiary has the power to invade the corpus of a trust, will the value of the trust assets over which the income beneficiary has the power be includable in the income beneficiary’s gross estate upon the income beneficiary’s death?

  5. Are life insurance proceeds includable in an insured’s estate if they are payable to an irrevocable trust and the trustee has the power to use them for payment of the insured’s estate debts and death taxes?

  6. If a grantor funds his or her life insurance trust by transferring income-producing property to the trustee, is the value of the funding property includable in the grantor’s gross estate?

  7. If a grandparent creates a funded irrevocable life insurance trust with policies on the life of his or her child for the benefit of grandchildren, is anything includable in the grantor’s gross estate?

  8. How is a “reversionary interest trust” taxed under the estate tax law?

  9. What is the reciprocal trust doctrine, and how does it affect life insurance trusts?

Loans on Life Insurance

  1. Is a life insurance policy loan deductible as a claim against the estate?

Marital Deduction

  1. May a trust intended to qualify for the marital deduction as a “power of appointment trust” authorize the trustee to retain or acquire life insurance policies?

  2. May a trust intended to qualify for the marital deduction as qualified terminable interest property (“QTIP”) authorize the trustee to retain or acquire life insurance policies?

  3. If a decedent directs his or her executor or a trustee to buy a nonrefund life annuity for the decedent’s surviving spouse, will the annuity qualify for the marital deduction?

  4. When will life insurance or annuity proceeds payable to the surviving spouse qualify for the marital deduction?

  5. Will life insurance or annuity proceeds qualify for the marital deduction if they are payable to the surviving spouse under a settlement option with the surviving spouse’s estate designated as contingent beneficiary? What if they are payable to the surviving spouse as a straight life annuity?

  6. Can life insurance settlements naming the spouse as primary beneficiary and other persons as contingent beneficiaries be arranged so that the proceeds qualify for the marital deduction?

  7. What is a general power to appoint the proceeds of a life insurance policy for purposes of the marital deduction?

  8. Does the use of a “delay clause” disqualify life insurance proceeds for the marital deduction?

  9. Does a common disaster clause disqualify life insurance proceeds for the marital deduction?

  10. Can operation of the Uniform Simultaneous Death Act result in loss of the marital deduction?

  11. Can proceeds of community property life insurance passing to the surviving spouse qualify for the marital deduction?

Multiple-Life Life Insurance

  1. Does estate taxation of a life insurance policy that insures more than one life differ from taxation of a policy that insures a single life?

Policyholder Other Than Insured

  1. If a policy owner who is not the insured dies before the insured, is the value of the unmatured life insurance policy included in the policy owner’s gross estate?

Settlement Options – Beneficiary’s Estate

  1. If the insured elects a settlement option for the insured’s primary beneficiary and names contingent beneficiaries, will the value of any unpaid life insurance proceeds be includable in the primary beneficiary’s estate?

  2. If the surviving income beneficiary dies possessing the power during his or her lifetime to appoint the life insurance proceeds only to his or her children, are the proceeds includable in the surviving income beneficiary’s estate?

  3. If life insurance proceeds are payable to the surviving spouse’s estate, but remain unpaid at the primary beneficiary’s death, is the money includable in the primary beneficiary’s gross estate?

  4. If an insured elects a settlement option naming contingent beneficiaries, but still gives the primary beneficiary power to withdraw proceeds, are life insurance proceeds remaining unpaid at the primary beneficiary’s death includable in the primary beneficiary’s estate?

  5. Can an insured give a primary beneficiary limited, noncumulative withdrawal rights without causing remaining unpaid life insurance proceeds to be includable in the primary beneficiary’s estate?

  6. If, under a settlement option, the primary beneficiary is given the power to revoke contingent beneficiaries and appoint to his or her estate, are life insurance proceeds remaining unpaid at the primary beneficiary’s death includable in his or her estate?

  7. If a beneficiary elects the settlement option, are life insurance proceeds remaining unpaid at the beneficiary’s death includable in his or her estate?

  8. How are life insurance proceeds valued for an insured’s estate tax return?

  9. If the amount of life insurance proceeds collectible from the insurer is not determinable when the estate tax return is filed, what amount is reportable on the return?

Gift Tax Issues

  1. Can gift tax be collected from the donee of a life insurance policy or proceeds?

  2. Does gift taxation of a life insurance policy that insures more than one life differ from taxation of a policy that insures a single life?

  3. Do premiums gratuitously paid on life insurance owned by and payable to another constitute gifts?

  4. Do premiums paid by one of several beneficiaries of an irrevocable life insurance trust constitute gifts to the other beneficiaries?

  5. If a life insurance policy is owned by someone other than the insured, is there a gift when the insured dies and the proceeds are paid to the owner’s designated beneficiary?

Community Property

  1. Does a taxable gift occur when a donor spouse assigns community property life insurance to a donee spouse?

  2. If one spouse uses community property to purchase life insurance on either spouse’s life and names a child as beneficiary, does the death of the insured spouse give rise to a taxable gift from the noninsured spouse?

Death-Benefit-Only Plans

  1. Are death-benefit-only (“DBO”) plans subject to gift tax?

Gift Tax Annual Exclusion

  1. May the annual exclusion of $13,000 for gifts to each donee be applied against gifts of life insurance policies and premiums?

  2. When is the gift of a life insurance policy considered the gift of a future interest, that deprives the donor of the gift tax annual exclusion?

  3. Is the annual exclusion available where an insured transfers ownership of a life insurance policy to two or more donees jointly?

  4. Will the gift of a life insurance policy fail to qualify for the annual exclusion merely because the policy has no cash value?

  5. Does the outright gift of a life insurance policy qualify for the gift tax annual exclusion even if the gift is to a minor?

  6. Where a life insurance policy has been given away, are premiums subsequently paid by the donor gifts of a present interest qualifying for the annual exclusion or a future interest?

Gifts Within Three Years of Death

  1. If an insured, within three years of his or her death, makes a gift of life insurance on which the insured pays a gift tax, is the gift also subject to estate tax?

Disability Provisions Under Life Policies

  1. Are premiums paid for disability provisions under a life insurance policy deductible as medical expenses?

  2. Is disability income payable under the provisions of a personal life insurance policy included in gross income?

  3. Are life insurance premiums that have been waived because of the insured’s disability taxable income to the insured?

  4. If a corporation attaches a disability income rider to a key person life insurance policy, what are the tax consequences to the corporation and to the key person?

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