Maxine Aaronson, Attorney at Law
Attorneys discussing a case. Glasses resting on documents depicting charts/diagrams. The word 'strategy' is highlighted. Puzzles coming together.

Tax Newsletter

Tax Implications of Life Insurance Proceeds

A common misconception about life insurance is that it is “tax-free.” While the build up in cash value of a life insurance policy is typically not subject to any income tax, the death benefit payable on the policy may be used for the purposes of calculating any estate taxes that may be owed upon your death.

The key to whether this happens is ownership. If you own a policy at the time of your death, or have retained any ownership rights in the policy, the full amount of the life insurance proceeds will be included in the calculation of the taxable estate.

Example

If you die owning three life insurance policies with a death benefit of $2,000,000 each (assuming they are your only assets), and the applicable unified credit for estate and gift taxes in the year of death is $5,250,000, your taxable estate would be $750,000, with taxes owed up to 40%, or $300,000.

ILITs & Taxation

An attractive option to avoid taxation calculations based on the death benefit is to create an Irrevocable Life Insurance Trust (ILIT) to own your life insurance policies. Policies owned by an ILIT may be excluded from your taxable estate.

Planning ahead is critical. If you already own life insurance, you must create an ILIT and transfer ownership in your life insurance policies to the ILIT at least 36 months prior to your death. Otherwise, the death benefit may be includable in your taxable estate.

Your tax attorney or estate planning attorney can advise you about this important option.

  • Bankruptcy and Federal Tax Obligations
    When the debts of an individual or business entity exceed the fair market value of assets, one option is to seek protection from creditors under U.S. Bankruptcy laws. There are several forms of bankruptcy actions that may be filed,... Read more.
  • Reasonable Cause for Nonpayment of Income Taxes
    When a taxpayer fails to file a tax return or to pay a tax that is due, the IRS will impose a penalty. However, a taxpayer will be excused from paying the penalty for failure to file or pay if he or she shows that there was reasonable... Read more.
  • Claiming a Federal Tax Credit for the Elderly Person and Disabled
    There are numerous laws and programs that benefit elderly taxpayers on local, state and national levels. Among them is a direct federal tax credit for elderly and disabled taxpayers. This particular tax credit includes a provision that... Read more.
  • Marital Deductions & Non-Citizen Spouses
    A QDOT is a specific type of marital deduction trust that is designed to ensure that non-citizen spouses will eventually pay any taxes that may be due upon distribution of the principal from the trust, even if the surviving spouse... Read more.
Law Commentary Legal News