A taxpayer owns a life insurance policy with a cash surrender value of $50,000 and a face value of $500,000. They have paid $20,000 in premiums. They surrender the policy for cash. What is the taxable amount?

Answer options:

$50,000 ordinary income.

$30,000 capital gain.

$30,000 ordinary income.

How to approach this question

1. Calculate Gain = Cash Received - Premiums Paid. 2. Character = Ordinary (not sale or exchange of a capital asset).

Full Answer

C.$30,000 ordinary income.✓ Correct

IRC §72(e). Amounts received upon surrender of a life insurance contract are included in gross income to the extent they exceed the investment in the contract (premiums paid). $50,000 - $20,000 = $30,000. The character is ordinary income.

Common mistakes

Treating the gain as capital gain.

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