An insured paid total premiums of $30,000 on a life insurance policy. At the insured's death, the beneficiary receives a $250,000 death benefit in one lump sum. How much is includable in the beneficiary's gross income for federal tax purposes?
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Answer & full 3-part explanation (select an option above, or peek)
Why C is correct
IRC §101(a) excludes life insurance proceeds paid by reason of the insured's death from the beneficiary's gross income. The amount of premiums the insured paid does not reduce the exclusion — the entire $250,000 is tax-free to the beneficiary, and no portion is reported as income. The premium cost basis is relevant to the policyowner during life (for withdrawals or surrenders), but it is not relevant to the beneficiary receiving a death benefit. Because the payment is by reason of death and received in a lump sum, the correct includable amount is zero, regardless of the large gain the policy produced over the premiums paid.
Why the other options are wrong
- A) $220,000 subtracts the premiums from the death benefit as if the economic gain were taxable; but death proceeds are excluded in full under §101(a), so no such subtraction is made.
- B) $250,000 would be correct only if death proceeds were taxable income; under §101(a) the full amount is excluded from the beneficiary's gross income. The exclusion applies to the entire benefit.
- D) $30,000 confuses the policyowner's premium basis with the beneficiary's tax result; premiums paid are not taxed and do not create taxable income at death. They merely reduce the owner's basis during life.
Memory hook
Premiums paid do not shrink the exclusion — the beneficiary's $250,000 arrives with a $0 tax bill.