A business owns a key-person life insurance policy on a vital employee and receives the $500,000 death benefit when the employee dies. For federal income tax purposes, the death benefit is:
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Answer & full 3-part explanation (select an option above, or peek)
Why B is correct
Death proceeds from a life insurance policy are excluded from gross income under IRC §101(a), and this exclusion applies when a business is the owner and beneficiary of a key-person policy. Even though the premiums were not deductible, the death benefit is received income-tax-free. The business uses the proceeds for recruitment costs, debt repayment, or loss recovery after the employee's death. Unless the policy was transferred for value, the business recognizes no taxable gain on the proceeds. In short, the business is made whole by a tax-free recovery of the economic loss.
Why the other options are wrong
- A) The proceeds are not ordinary income to the business; §101(a) excludes life insurance death proceeds from the gross income of the recipient. The business is a normal recipient of the exclusion.
- C) There is no taxable gain computation for the business at death; the full death benefit is excluded, regardless of the premiums paid over the years. Premiums do not create a taxable gain.
- D) Death proceeds are not capital gain; the §101(a) exclusion removes the entire benefit from income for the business. The whole payout is excluded. It is not taxed as a gain.
Memory hook
The business receives its key-person payout with no income tax — §101(a) works for firms too.