When Taxes Will Apply to a Life Insurance Death Benefit

The common misconception is that life insurance is not subject to taxation, which is half-true and half-false. Life insurance is almost always not subject to income taxation; however, under current tax law (2003), it is still subject to estate taxation.

As a general rule, life insurance death proceeds are excusable from the beneficiary’s gross income (IRC Sec. 101(a)(1)).

Death proceeds from single-premium, term life insurance, periodic-premiums, or flexible premium life insurance policies are received income tax-free by the beneficiary regardless of whether the beneficiary is an individual, a corporation, a partnership, a trustee, or the insured’s estate (Treasury Regulation 1.101-1).

However, the death benefits may be subject to estate taxes, gift taxes, and any other inheritance tax.

This is a good reason to visit with an estate-planning professional – somebody who is appropriately licensed and qualified.

How to roughly calculate your potential estate tax:

1. Total you gross estate; including anything of value in which you have an ownership interest. For example, home and other real estate; retirement plan balances; stocks, mutual funds and other investments; and businesses and life insurance proceeds (not held outside your estate).

2. Subtract all allowable deductions, such as funeral and administrative expenses, mortgages, loans, credit card debt, charitable deductions, etc.

3. If you have a positive net estate, this is your net taxable estate.

4. Use the table below to calculate your tentative estate tax.

YearExemption $Maximum Tax BracketUnified Credit
2011$1 million45 percent245,800
2013 & beyond$5.25 million40 percent$1,772,800

Your unified credit is subtracted from your tentative tax, if unused during your lifetime. The unified tax credit means that no federal estate tax is payable on a taxable estate equal to your exemption equivalent. Estate taxes are due when your tentative tax is greater than your unified credit.

Your estate may be valued at death or six months later, whichever is more beneficial. If you own a farm or closely held business, your method of paying taxes will be different.

Use this information to generate a rough idea of your potential estate tax. Be sure to check out the IRS website or consult with a properly certified estate-planning adviser.

Note: This information is based on certain life insurance policy, tax, and legal assumptions, but it not meant as legal or tax advice and is, also, subject to change. Only your attorney, accountant, or other tax professional can give you such advice.  Please consult your tax adviser as rates and exemptions may be subject to change.

Tony Steuer is an author and advocate for financial preparedness. Tony Steuer, CLU, LA, CPFFE, helps people make sense of the financial world in a way that’s easy for them to understand. His books including, “GET READY!,” “Insurance Made Easy,” and “Questions and Answers on Life Insurance,” have won numerous awards. Tony is the founder of the GET READY! Initiative which includes the GET READY! financial organization system, the GET READY! Financial Preparedness Club, GET READY! Podcast, and the GET READY! Financial Principles, a best practices playbook for the financial services industry. Tony served as long-term member of the California Department of Insurance Curriculum Board. Tony is regularly featured in the media including the New York Times, the Washington Post, Fast Company, and other media. He has also appeared as a guest on television shows, such as ABC’s “Seven on Your Side.” Visit https://tonysteuer.com/ to join the GET READY! Financial Preparedness Club and access free resources.

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