A policyowner has a cost basis of $100,000 in a policy that has become a MEC and takes a $30,000 distribution. Under the LIFO rule for MECs, this distribution is:

Why A is correct

The LIFO rule for MEC distributions reverses the normal life insurance ordering: amounts received from a MEC are treated as taxable gain first, before any recovery of the cost basis. Therefore, even a $30,000 distribution from a MEC with a $100,000 basis is fully taxable as ordinary income because the gain is deemed to come out first. This is the opposite of a non-MEC policy, where the basis is recovered before any gain is taxed. A 10% penalty may also apply if the owner is under age 59½.

Why the other options are wrong

• B) For a MEC, the basis is not recovered first; the LIFO rule taxes gain first, so a distribution below the basis can still be fully taxable. The basis stays untouched in this distribution.
• C) MEC distributions are ordinary income, not capital gain; the gain-first ordering does not change the character of the income. Ordinary income is the character of the gain. Capital gain never applies.
• D) Repaying the distribution does not reverse the tax; the distribution is taxable when received regardless of any later repayment. Repayment is irrelevant to the tax. The tax event has already occurred.

Memory hook

MEC = LIFO, so even small withdrawals hit taxable gain first — basis waits at the back of the line.