For California state personal income tax purposes, a life insurance death benefit received as a lump sum by a California resident beneficiary is:
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Answer & full 3-part explanation (select an option above, or peek)
Why D is correct
California's Personal Income Tax Law conforms to the federal Internal Revenue Code, including IRC §101(a), so life insurance proceeds paid by reason of the insured's death are excluded from California taxable income as well as federal taxable income. California has no state estate or inheritance tax, so the beneficiary pays no California tax on the proceeds. The exclusion applies to any named beneficiary regardless of relationship to the insured. A California-licensed agent should be able to confirm that death proceeds that are tax-free federally are equally free of California personal income tax when advising residents.
Why the other options are wrong
- A) The relationship between beneficiary and insured does not affect the §101(a) exclusion; a business or friend as beneficiary receives the proceeds tax-free too, so spousal status is not a condition.
- B) California conforms to IRC §101(a) for this purpose, so the death benefit exclusion is recognized for state personal income tax, not rejected by the state. A conforming state follows the federal result.
- C) California abolished its state estate and inheritance taxes, and there is no 2.35% inheritance tax imposed on the beneficiary of a life insurance policy. The beneficiary therefore owes no state inheritance tax on the proceeds.
Memory hook
Federal exclusion travels to California too — conformity means tax-free in both columns.