Taxation✓ Verified · outline & fact-checked · Sep 2026Difficulty 1/5
A life insurance beneficiary receives a death benefit as a lump sum. For federal income tax purposes, this death benefit is generally:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Under Internal Revenue Code Section 101(a), life insurance death proceeds paid in a lump sum to a beneficiary are generally exempt from federal income tax. This tax advantage is a primary reason life insurance is used for family and estate protection. If the proceeds are instead received under a settlement option that pays interest, the interest portion is taxable while the principal remains tax-free. Estate tax treatment is separate and depends on whether the proceeds are included in the insured's gross estate.
Why the other options are wrong
- B) Lump sum death proceeds are not ordinary income; IRC Section 101(a) excludes them from the beneficiary's gross income. The exclusion under Section 101(a) is complete for lump-sum death proceeds and is not limited by policy duration.
- C) The proceeds are not a sale or exchange, so they are not capital gain; they are an excluded payment under the tax code. A capital gain arises from a sale or disposition, and a death benefit is neither.
- D) There is no two-year holding requirement; the exclusion applies to the death benefit regardless of how long the policy was in force. The exclusion is unconditional once the insured dies and the proceeds are paid.
Memory hook
Death benefit lump sum: IRS takes no slice. Interest earned on it later? That slice is taxed.