Simply stated, single lump-sum death benefits received from a life insurance policy that was not owned by the deceased is not taxable. One spouse can own a policy that bequeaths death benefits to the surviving spouse without the funds being taxable; but, this is not the case if the named beneficiary is not a surviving spouse. When someone is planning for the financial security of individuals in the event of his or her death; it helps to understand how death benefits from a life insurance policy can be classified as non-taxable or taxable.
<strong>Non-Taxable Death Benefits</strong>
1. Single payments from policies, not owned by the deceased are not subject to taxation.
2. Policy holders can transfer ownership to another person so that the values of the death benefits are not included in the values of the estates of the deceased. To ensure that the death benefits do not become part of someone’s estate, and therefore subject to taxation, a policy transfer must have been completed three years prior to the death.
3. If a policy is placed into a trust there is a $14,000 limit on the amount of non-taxable death benefits. Amounts in excess of $14,000 can be viewed as a gift and subject to a gift tax.
4. Death benefits that are paid in multiple installments are non-taxable up to the face value of the policy. Funds received in excess of the policy’s face value will be taxed as interest income.
<strong>Taxable Death Benefits</strong>
1. If the deceased was the owner of the life insurance policy, the value of the policy automatically becomes part of the deceased’s estate and, depending on the value of the estate, subject to federal and applicable state unique estate taxes.
2. If a policy owner transferred ownership to another party and that person dies before the named individual on the insurance policy, the benefits will be paid to the deceased’s estate and, depending on the size of the estate, might become subject to taxation.
The federal tax codes are extensive and complicated. It is understandable that individuals who are the recipients of life insurance benefits might not know whether to include death benefits on their tax forms. The Internal Revenue Service has developed Publication 525, Taxable and Nontaxable Income, to help taxpayers understand what types and sources of income need to be included in their total income and what income does not, www.irs.gov/pub/irs-pdf/p525.pdf .