A policyowner surrenders a whole life policy and receives a cash surrender value that exceeds the total premiums paid. For federal income tax purposes, the excess:

Why A is correct

Under Internal Revenue Code Section 72(e), when a life insurance policy is surrendered and the amount received exceeds the policyowner's cost basis (generally total premiums paid), the excess is taxable as ordinary income. Only the gain above basis is taxed; the return of the cost basis is tax-free. This mirrors the general taxation of cash value growth: the policyowner may defer tax on the inside buildup while the policy is in force, but any gain extracted at surrender becomes currently taxable.

Why the other options are wrong

• B) Life insurance is not categorically tax-free at surrender. Only death proceeds enjoy the income tax exclusion; gains received at surrender are taxable as ordinary income under Section 72(e).
• C) Gain on surrender is ordinary income, not capital gain. The Internal Revenue Code does not treat life policy surrender gains as capital transactions.
• D) There is no repayment obligation to the insurer. The policyowner keeps the surrender proceeds, and only the federal income tax on the gain above basis is due.

Memory hook

Surrender = settle the account. Back your basis tax-free, but the profit above basis is ordinary income.