Taxation✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
A policyowner surrenders a whole life policy and receives the cash surrender value. Under IRC Section 72, the amount subject to income tax is the amount by which the cash value:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
When a policy is surrendered, the policyowner recovers the cost basis (premiums paid, minus any dividends or tax-free amounts already received) free of tax. Only the amount of cash value above the cost basis is taxable as ordinary income under IRC Section 72(e). This is why heavily funded policies can produce a taxable gain at surrender, even though the death benefit itself would have been tax-free.
Why the other options are wrong
- B) The comparison is between the cash value and the cost basis, not between the cash value and the face amount.
- C) The cash value cannot exceed the death benefit in this context; the taxable amount is gain over basis.
- D) Borrowed amounts are taxable only to the extent they represent gain over basis and exceed basis, not merely because a loan exists.
Memory hook
Surrender tax = cash out minus premiums in, taxed only on the profit. Basis comes home first, free.