Under the Internal Revenue Code, a lump-sum life insurance death benefit paid to a named beneficiary is generally:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
IRC Section 101(a) excludes life insurance proceeds paid by reason of the insured's death from the recipient's gross income. This means the beneficiary generally receives the lump-sum death benefit free of federal income tax. Important nuances exist: if the proceeds are left with the insurer and interest is paid, that interest is taxable; if the policy was transferred for value, part of the proceeds may be taxable; and if the insured owned the policy at death, the proceeds may be includible in the insured's gross estate for estate tax purposes. The income tax exclusion on the death benefit itself, however, is the general rule.
Why the other options are wrong
- B) The death benefit is not ordinary income. The Section 101(a) exclusion removes it from the beneficiary's gross income.
- C) Insurance proceeds are not capital assets, so no capital gain arises when the death benefit is paid.
- D) Death proceeds are not wages and are not subject to payroll or Social Security taxes of any kind.
Memory hook
The death benefit check is tax-exempt under IRC Section 101(a).