ExpertMedium1 markMultiple Choice
CPA · Question 23 · Area 2: Financial Planning
An individual owns a life insurance policy on their own life with a face value of $500,000. They have paid $40,000 in premiums. The cash surrender value is $60,000. They surrender the policy for cash. What is the taxable amount?
An individual owns a life insurance policy on their own life with a face value of $500,000. They have paid $40,000 in premiums. The cash surrender value is $60,000. They surrender the policy for cash. What is the taxable amount?
Answer options:
A.
$0
B.
$20,000 Ordinary Income
C.
$20,000 Capital Gain
D.
$60,000 Ordinary Income
How to approach this question
1. Calculate Basis: Premiums paid = $40,000.<br/>2. Calculate Proceeds: Cash surrender value = $60,000.<br/>3. Calculate Gain: $60,000 - $40,000 = $20,000.<br/>4. Determine Character: Gain on surrender of life insurance is Ordinary Income (interest/earnings component).
Full Answer
B.$20,000 Ordinary Income✓ Correct
The gain on the surrender of a life insurance policy is the excess of the cash surrender value over the investment in the contract (premiums paid). $60,000 - $40,000 = $20,000. This is taxed as ordinary income.
Common mistakes
Treating the gain as capital gain.
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