Income Tax Reporting For Recipients Of Life Insurance Proceeds

Life insurance is usually purchased with the intent to provide future support for one or more beneficiaries. Some life insurance policies allow policyholders to receive accelerated death benefits themselves. Any recipient of life insurance payments may be required to report a portion of the proceeds as taxable income.

The payment to a beneficiary for the face amount of a life insurance policy is generally not taxable. The face amount is the sum specified in the insurance contract as payable upon death of the insured. Many distributions are not so straightforward, and some payments may result in taxable income to the payee.

Interest income

If you receive interest on life insurance proceeds, the interest is taxable. The payment of interest may be due to a delay in the distribution of the face amount. Interest may also be paid to a beneficiary who receives payments in installments.

A beneficiary who receives installment payments must determine how much of each payment to report as interest income. The face value the beneficiary is entitled to receive is divided by the number of scheduled payments to arrive at the tax-free portion of each periodic payment. Any amount received in excess of that tax-free portion is taxable as interest income.

Cash surrender value

Some life insurance contracts accumulate a cash surrender value for the policyholder. If you choose to redeem your policy and receive the cash surrender value, you become the payee. The surrender value amount is taxable only to the extent that it exceeds the net cost of your premiums paid in during the life of the policy.

Viatical settlement for the terminally ill

Tax regulations make special provisions for policyholders who are in ill health. Your policy may allow you to assign the death benefits to a viatical settlement company. Payments from a qualified viatical settlement company are not taxable if a medical doctor has certified that the recipient is terminally ill, with a life expectancy of 24 months or less.

Long-term care for the chronically ill

Federal income tax differentiates between the terminally ill and the chronically ill. If you are not terminally ill, payments received through a life insurance policy to cover the cost of qualified long-term care may be nontaxable. A chronically ill individual is someone who requires personal assistance in daily activities such as walking and bathing.

Each year, the IRS establishes a limit on life insurance payments paid per diem that may be received tax-free by a chronically ill policyholder. For 2015, the per diem limit is $330. If actual costs are higher, insurance payments designated to cover the higher cost may be received tax-free. Contact a tax specialist like Capital Accounting And Tax Service Inc for more information on the taxation of insurance.