Life insurance death proceeds paid in a single lump sum to a beneficiary are generally:

Why A is correct

Under IRC §101(a), life insurance death proceeds paid in a lump sum to a beneficiary are generally excluded from the beneficiary's gross income and are free from federal income tax. This favorable treatment is one of the primary reasons life insurance is used for income replacement and estate liquidity. If the proceeds are instead received under a settlement option that pays installments, the interest portion of each payment is taxable while the principal, or death benefit, portion remains tax-free. The tax-free status applies to the death benefit itself, not to interest earned on it.

Why the other options are wrong

• The death benefit principal is not ordinary income; only the interest earned when proceeds are held and paid later is taxable to the recipient. Accordingly, this option is not correct because it does not match the specific rule or product that is described in the question.
• Death proceeds are not treated as capital gains; capital gain treatment applies to assets sold at a profit, not to insurance death benefits. This option therefore does not match the facts presented in the question and is not the correct answer to select.
• No 10% penalty applies to life insurance death proceeds; penalty provisions relate to early distributions from retirement accounts and modified endowment contracts. This answer describes a different situation from the one in the question and is therefore incorrect under the facts given here.

Memory hook

A lump-sum death benefit is tax-free under IRC Section 101(a).