FIT INCOME TAXATION, IRC 101(a) – proceeds of life insurance payable by reason of death not included in gross income, except –
a transfer for value rule, 101(a)(2) – if life insurance contract is transferred for a consideration, proceeds over and above purchaser’s basis is ordinary income.
b Example – F is insured and owner of $100,000 life insurance policy that names daughter D as primary beneficiary. CSV = $9,500. D buys policy from F for $9,500. After transfer, D pays $6,500 in premiums to keep policy in force. F dies and D is paid $100,000. The proceeds not included in F’s GE b/c he owned no incidents of ownership. D has basis of $16,000 ($9,500 + $6,500) and under transfer for value rule, realizes $84,000 in gain taxed to D as ordinary income.
c Example 2 – Same facts except F gives all incidents of ownership of policy to D. Now, there are no gift tax consequences b/c falls within the $10,000 annual exclusion. F dies more than 3 years later and the $100,000 paid to D is not included in F’s GE and there are no income tax consequences to D.
d Example 3 – D applies for policy on F’s life. F is insured but D is owner and pays all premiums. F dies several years later and $100,000 paid to D. The policy proceeds are not included in F’s GE for FET purposes and there are no income tax consequences to D.
e Return to example 1 where F is insured with D as beneficiary. F cashes the policy in for $9,500 during his lifetime. He only pays income tax on the amount that $9,500 exceeds his basis in policy.
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