Income Taxation of Life Insurance - Common Questions Answered Live!

1. **Do beneficiaries pay income taxes on the death benefit received?** Generally, life insurance proceeds paid upon the insured’s death are not included in the beneficiaries’ taxable income. However, there are two exceptions: Transfers-for-value and Employer-owned life insurance.
2. **Are premiums deductible?** In general, premiums are not tax-deductible if the taxpayer is directly or indirectly a beneficiary of the policy. For specific details, consult your tax advisor.
3. **Do policyowners have to pay taxes on each year’s cash value increase?** No, life insurance policy values increase on a tax-deferred basis.
4. **What qualifies as life insurance for federal tax purposes?** The Internal Revenue Code (IRC) defines life insurance, with two alternative tests: the Cash Value Accumulation Test (CVAT) and the Guideline Premium Test (GPT).
5. **Are all life insurance policies treated the same for income tax purposes?** No, if the total premium paid into a policy exceeds a certain limit, it may be classified as a Modified Endowment Contract (MEC), which has less favorable tax treatment. Non-MEC policies are discussed separately.
6. **What is the cost basis of a life insurance policy?** The cost basis represents the owners' investment in the policy, and it is affected by premiums paid and non-taxable withdrawals.
7. **Can a policyowner claim an investment loss (on his/her tax return) if the cost basis is higher than the proceeds received from a full surrender or policy lapse?** No, life insurance is not treated as an investment asset, so losses resulting from surrender or lapse are not deductible.
8. **Is loan interest paid on a life insurance policy tax-deductible?** Generally, interest paid on loans from individually owned life insurance contracts is not tax-deductible.
9. **What is a 1035 exchange, and what are the tax consequences?** A 1035 exchange allows the exchange of certain insurance policies or annuity contracts without recognizing a gain on the transaction. Consult the video for detailed examples.
10. **Can a policy with an outstanding loan be exchanged for a new policy under a 1035 exchange?** It depends on the insurance company. In some cases, the loan can be carried over, while in others, it may need to be paid off during the exchange.
11. **Can a policyowner take a charitable income tax deduction for donating a life insurance policy to charity?** Yes, the policyowner can take a charitable income tax deduction if full control of the policy is transferred to the charity.
12. **If a contributor makes premium payments to a life insurance policy owned by charity, is he or she eligible for a deduction?** Yes, under specific conditions, the contributor may be eligible for a charitable income tax deduction.
13. **Are withdrawals/distributions from a life insurance policy subject to income tax?** Distributions are first treated as a return of the cost basis. Only amounts exceeding the cost basis are subject to income tax.
14. **Are policy loans taxable?** Policy loans are not treated as distributions unless the policy lapses while the loan is outstanding.
15. **What are the consequences if a life insurance policy lapses with an outstanding loan?** The total policy debt is considered a distribution to the policyowner, resulting in taxable income if it exceeds the cost basis.
16. **If a life insurance policy is surrendered, what are the tax consequences?** The gross surrender proceeds that exceed the cost basis are included in the policyowner’s income.

Join our live session as we delve deeper into the intricacies of income taxation of life insurance. Remember to consult your tax advisor for personalized advice, as tax laws can be specific to individual circumstances. Don't forget to like, subscribe, and share this valuable information with others!

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All advice and/or opinions expressed in our videos are the result of our experience in the insurance and financial industries. Any action taken based on the information expressed in our videos is the sole responsibility of the viewer. All content produced is for informational purposes only.

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