Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Key notes will appear in this box automatically as the audio review proceeds. When the professor (s) announce the session has concluded, you can continue with the quiz at the end of the lesson by following the links.

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Types of Death Benefits Generally Excludible from Gross Income Life insurance death benefits payable by reason of death in lump-sum payments Death benefits payable under accident & health contracts Death benefits payable under workers’ compensation insurance Death gratuity payments by US government to families of deceased military personnel

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Tax Implication of Death Proceeds Held for Future Withdrawal & Exceptions Interest on the proceeds paid to the beneficiary is fully taxable Principal of the death benefits is received tax free Amounts paid as a survivor annuity, because of the death of a public safety officer killed in the line of duty, are FULLY tax exempt (interest not taxed) Beneficiary may exclude up to $1,000 of interest, if the option is installment for the death of an insured that occurred before Oct. 23, 1986

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Terminally ill Insured An individual who has been certified by a physician as having an illness or condition that can be expected to result in death within 24 months of the date the certification is given Requirements to Receive Tax-Free Accelerated Benefits Insured must be terminally or chronically ill Amount received must be paid by the insurance company or by a licensed viatical settlement provider Insured must not have a financial interest in the business conducted by the beneficiary Contract must be treated as a qulaified long-term care insurance contract under definition of the IRC

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions The 7-year or 4-out of -7 exception The $100 a year exception The unforeseen event exception The trade or business exception

Assignment 11 Income Taxation of Life InsuranceTTax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Transfer-for-Value Rule A tax law providing that where a policy transferred by assignment or otherwise for a valuable consideration matures by reason of death, the transferee will be liable for income tax on the amount of death proceeds in excess of the actual value of the consideration paid for the contract plus the total of net premiums and other amounts subsequently paid by the transferee. Exceptions to the Transfer-for-Value Rule Transfers to the insured Transfers to a partner of the insured Transfers to a partnership in which the insured is a partner Transfers to a corporation in which the insured is a shareholder or officer Transfers in which the transferee’s basis is carried over from the transferor

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Insurable Interest The legal principle that requires the policy-owner under a life insurance policy to have a sufficient business or personal relationship with the insured at the time of policy inception

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Life Insurance as a Charitable Contribution – Requirements A donor may deduct the premiums (subject to charitable contribution limitations) paid on life insurance owned by a qualified charitable organization, as long as the charity is owner of the policy and has the exclusive right to the cash in the policy Premium Payments for Life Insurance Deducted as Alimony – Requirements Premium payments will be deductible as alimony for the payer spouse and taxable for the payee spouse if Payments are made in cash and terminate at death of payee-spouse Payments are made under divorce decree The parties are not members of the same household and do not file joint tax returns Payments are not for child support

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Taxation Criteria for Life Insurance Policy Withdrawals – Dividends Because dividends are viewed as return on a portion of premium, they are not taxable income unless the aggregate dividends received exceed taxpayer’s contract basis Interest earned on dividend accumulation is taxable in the year taxpayer has right to withdraw the interest How are Withdrawals of a Cash Value from a Life Policy Taxed? Generally, withdrawals are taxed on a FIFO (first-in, first-out) basis LIFO is used for MECs Withdrawals made during the first 15 policy years

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less 60-Day Rule If the policy-owner elects the installment option within 60 days of the date of maturity/surrender of the policy, the tax on the unrealized gain may be deferred until installments begin If this option is not elected within 60 days, the owner will be taxed on the total unrealized gain at the time of the policy’s surrender/maturity and the investment in the contract will be increased to fair market value on the date of maturity/surrender

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Single Premium Contract – A contract for which All premiums are paid within 4 years from the date of purchase OR An amount is deposited with the insurer for payments of a substantial number of future premiums = interest is NEVER deductible

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Key Person – For purposes of determining the deductibility of interest payments on a loan from an insurance contract, an individual insured that is an officer or 20-percent owner of the company Key Person Rule A rule that provides that interest on loan amounts not in excess of $50,000 per insured person is deductible, if the insured or other covered person under the contract is a key person Key Person Rule Restrictions If the person covered is a key person (officer or 20% owner) in the company (applicable after June 21, 1986 Total per business taxpayer cannot exceed greater of 5 individuals OR The lesser of 5% of total number of officers & employees of business taxpayer OR 20 individuals

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Treatment of Disability Income Payments Income payments are received tax free unless the payments are paid by an employer to fund a wage-continuation plan for employees and the benefits are paid directly from the insurance company to the individual Allowances for Contracts with Death Benefits of $10,000 or Less An annual allowance of $75 may be added to the 7-pay test premium for policies with face values of $10,000 or less

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Contingent Beneficiary With respect to a life insurance policy, the person who will receive the death proceeds of the policy if the primary beneficiary does not survive the insured Taxation to Contingent Beneficiaries In the same manner as was the primary payee If primary payee dies during a period of guaranteed payments from a life income settlement, contingent beneficiary will not have taxable income until the total of the amounts received by both primary payee and the contingent beneficiary exceed the investment in the contract

Assignment 11 Income Taxation of Life Insurance Tax Treatment of Modified Endowment Contracts Types of Death Benefits Generally Excluded from Gross Income Tax Implications of Death Proceeds Held for Future Withdrawals & Exceptions Requirements Necessary to Receive Tax-free Accelerated Death Benefits – (Terminally ill insured) Disallowance Rule for Systematic Borrowing Plan Contracts – Exceptions Transfer-for-value Rule – Exceptions Insurable Interest Life Insurance as an Charitable Contribution – Requirements Premium Payments for Life Insurance Deducted as Alimony – Requirements Taxation Requirements for Life Insurance Policy Withdrawals – Dividends (Including Cash Value) Single Premium Contract – Description 60-Day Rule Key Person (Rule, Restrictions) Treatment of Disability Payments Contingent Beneficiaries Modified Endowment Contracts (MEC) Rules (7-pay test, Special Income Rules, Net Level Premium) Contracts with Death Benefits of $10,000 or Less Modified Endowment Contract (MEC) A life insurance contract that fails to meet the Internal Revenue Code’s 7-pay test. Distributions from such a contract are, therefore, taxed less favorably than are those of other life insurance contracts 7-Pay Test If the total premium paid into the policy in the first 7 years, or in the 7 years following a material change in it, exceeds the sum of the net level premiums that would be needed to pay up the policy in 7 years, the policy is an MEC Net Level Premium An artificially constructed amount based on reasonable mortality charges, an assumed interest rate an (in some cases) reasonable insurance company expense charges, used in determining whether a life insurance contract is an MEC MEC Special Income Rules Policy loans and partial withdrawals of funds are subject to last-in, first-out (LIFO) treatment 10% penalty tax on taxable gains withdrawn from the contract before age 59 ½ years

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