Generally proceeds from a life insurance policy are not taxable income. The following is a list of most common scenarios concerning life insurance coverage.
Interest: If your claim was delayed before it paid, the proceeds from the insurance policy probably accrued interest between the date of death and the actual date of payment. Such interest is considered taxable income. You will probably receive a Form 1099-INT from the insurance company at the end of the year.
Policy Dividends: Policy dividends are usually not taxable. If the amount of dividends you receive exceeds the amount of the premiums paid for the policy, you may be liable to pay taxes on the difference. You will receive a Form 1099-DIV by January 31 citing the amount of dividends paid that must be included in your taxable income.
Cashing Out a Policy: If you decide to cash out a policy, you may have a taxable transaction. You will not be taxed on the entire sum. If you received more money from the cash-out than what you paid into the policy, that excess money is considered taxable. Premiums, rebates, premium credits, dividends or un-repaid loans will all be considered in calculating your taxable income.
Transferring the Ownership of the Policy: Sometimes, if you transfer the ownership of your life insurance policy to another party before your death for a price or other consideration, the proceeds paid to the beneficiary at your death could be considered taxable income to that beneficiary.
Accelerated Death Benefits: Many life insurance policies have accelerated death benefits options. If you have a terminal illness and your life expectancy is 12 or fewer months, you may claim the accelerated death benefits. These benefits are not taxable.
Viatical Settlements: A viatical settlement provider is an entity in the business of buying life insurance contracts on the lives of terminally ill individuals. Depending on the type of transaction, you may be taxed on some portion of the proceeds. Check IRS Code Section 101(g)(2)(B) or consult your tax professional.
Endowment contracts: An endowment contract is a form of life insurance coverage that guarantees a specific amount to be paid to the insured on a certain date. If the insured dies before that date, a beneficiary will receive the payout. Payments made to the beneficiary are not included as taxable income. Lump sum payments made to the insured at maturity are taxable if they exceed the cost of the policy.
Incidents of Ownership: The proceeds of your life insurance policy may be subject to federal estate taxes if you have incidents of ownership in the policy. If you have control over the policy – you can cancel it, surrender it, borrow against it, pledge or assign it, or can change the beneficiary – you most likely possess incidents of ownership in the policy, and the proceeds of the policy may be subject to federal estate taxes when you die.
There are many types of transactions involving a life insurance policy. If you have any questions before completing a transaction consult legal counsel.
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