Course 2 Module 12: Taxation of Insurance

If an insured with a $100,000 life insurance policy died after $3,000 of premiums had been paid, what amount of the death proceeds would be received tax-free by the beneficiary? 3,000 100,000 0 97,000

100k The entire $100,000 would be received income tax free by the beneficiary. With exceptions, this result applies irrespective of the cash value of the amount of premiums paid and regardless of who was listed as the policy owner, insured, beneficiary, or premium payor.

Under the transfer for value rule the death benefit amount that exceeds the new policy owner-beneficiary's adjusted basis is subject to income tax at ____________ rates when the insured dies. ordinary income capital gains estate tax generation skipping transfer tax

A Under the transfer for value rule the death benefit amount that exceeds the new policy owner-beneficiary's adjusted basis is subject to income tax at ordinary income rates when the insured dies. The transfer for value rule cannot be avoided by cancelling the transaction at a later time.

What is a dividend?

A dividend is an amount paid on participating insurance policies. The dividends received from a mutual life insurance company are not subject to federal income tax. The IRS views these dividends as a return of part of the premium and not as earned income. But, if dividends are paid to owners of stock, such dividends are a taxable return on their investment.

Select the items that can be included in death proceeds: I. The policy face amount II. Accidental death benefits III. The face amount of any paid-in-full additional insurance IV. The face amount of a term rider

All 4 Death proceeds include the policy face amount and any additional insurance amounts paid by reason of the insured's death, such as accidental death benefits and the face amount of any paid-in-full additional insurance or any term rider.

Disability Income Insurance

Employer Premiums: Premiums not included in employee's gross income. Premiums deductible by employer. Employer Benefits: Included in employee's gross income. May qualify for credit for elderly and disabled. Employee Premiums: Not deductible. Employee Benefits: Excluded from gross income.

Long-term care insurance:

In general, benefits are excluded from taxable income. Insurance premiums and out-of-pocket spending for LTC services qualify as medical expense deductions, and are 100% deductible up to specified age limits.

Gift of Insurance Proceeds Example:

Jan owns a insurance on her husband's life, with their children named as revocable beneficiaries. Jan will be deemed to have made a gift to the children in the full amount of the proceeds when they are paid at her husband's death. It is assumed that there is no intent to make a gift in the literal sense, but a taxable gift has been made nevertheless.

Assume Kuramo names his son, Abeo, the beneficiary of his $1 million life insurance policy and transfers the policy to him six years before his death. If Kuramo retained the right to change the beneficiary, the $1 million death benefit will be included in which estate? Kuramo's Abeo's Neither estate

Kuramo's At Kuramo's death the $1 million in death proceeds are included in Kuramo's estate since he retained the right to change the beneficiary. Although Kuramo transferred the policy to Abeo more than three years before his death, this incident of ownership causes the death benefit to be included in Kuramo's estate.

accelerated death benefit

Many insurers allow for an accelerated death benefit, or the early withdrawal of death benefits, in cases in which the insured is terminally ill. The IRS issued a regulation applying to the taxation of these early payments in June 1993.

Death Proceeds and Gross Estate Inclusion Example:

Mary is the insured and owner of a $10,200,000 Whole Life policy. She also is the owner of her son Ron's $100,000 Whole Life policy, which has a replacement cost value of $12,300. Her husband Ray is the insured owner of a $1,000,000 Whole Life policy on his life. Mary and Ray are named as beneficiaries on each other's policies. Both are co-beneficiaries on Ron's policy. If Mary died, her gross estate calculation would include the $10,200,000 death benefit on her policy and the $12,300 replacement cost value of Ron's policy. This would significantly increase the value of her gross estate. Likewise, if Ray died, his gross estate would include the $1,000,000 death benefit from this policy. By changing ownership so that Mary and Ray now owned the Whole Life policy on each other's lives, they would dramatically decrease the value of their gross estates. Upon their deaths, since neither owned the policy on their own lives, the death benefit amount would not be included in their gross estate. Instead, only the replacement cost value of insurance they owned on the lives of others would be included.

Health insurance taxation:

Medical benefits provide full or partial reimbursement for a wide range of health care expenses incurred by employees and their eligible dependents.

Define Transfer-for-Value

Sometimes a life insurance policy is sold for a valuable consideration. This is known as a transfer-for-value. A life insurance policy that is sold or exchanged for valuable consideration may cause the death benefit to be taxed in certain situations. Under the transfer for value rule the death benefit amount that exceeds the new policy owner-beneficiary's adjusted basis is subject to income tax at ordinary income rates when the insured dies. The transfer for value rule cannot be avoided by cancelling the transaction at a later time.

gift tax exclusion

The federal gift tax law is not aimed at the usual exchange of gifts associated with birthdays, holidays and similar occasions. The law permits the donor to make this type of gift without tax by excluding the first $15,000 of outright gifts in any one specific year to any one recipient. This annual $15,000 exclusion applies to gifts made to each recipient, irrespective of the number. Moreover, it is available year after year. An individual could give $15,000 to each of a large number of recipients each year, without incurring any gift tax liability. The exclusion is indexed for inflation. The IRC provides that the indexed exclusion is rounded to the next lowest multiple of $1,000. As the inflation adjustment occurs in multiples of $1,000, it can be several years between adjustments. The donor's exclusion is applied to each recipient individually, and if a recipient receives less than $15,000, the exclusion is limited to the actual amount of the gift.

Deductions

The gift tax marital deduction permits tax-free transfers between spouses. This deduction is available without limit for most types of property transferred to spouses. A married individual can make present interest gifts of $30,000 (indexed) per year to each beneficiary without incurring any gift tax liability, if the spouse consents to splitting the gift. As previously noted, gifts of a "present interest" mean the recipient or donee has an immediate right to use the gift without restriction. The IRC permits a full gift tax deduction for gifts to qualified charities. An individual can donate a life insurance policy to a qualified charity without incurring any gift tax, and will receive a charitable income tax deduction as well. Gifts to private individuals can never qualify for the charitable deduction, no matter how needy or deserving the donees may be.

The benefits of taxation of life insurance:

These include clauses like early withdrawal for those cases where the insured is terminally ill. Other benefits include dividends which do not incur federal income tax.

T or F: Robert Brown is married. He has a wife, Sarah, and a daughter, Jenny. He buys a policy in his name, and insures his wife and names his daughter as a beneficiary. At Sarah's death, Jenny receives the life insurance death proceeds as a gift from Robert.

True Premiums paid by an insured are gifts if the insured has no incidents of ownership in the policy and proceeds of the policy are payable to a beneficiary other than his or her estate. Premiums paid by a beneficiary on a policy that he or she owns are not gifts.

Gift of Insurance Proceeds

Under ordinary circumstances, life insurance death proceeds are not gifts. In some extraordinary instances, there may be a taxable gift, such as when one person owns a policy, a second is the insured, and a third is the beneficiary. A gift can be considered as occurring from the policyowner to the beneficiary at the insured's death. The amount of the gift equals the full amount of the insurance proceeds. A gift of endowment insurance proceeds likewise occurs when, upon the maturity of an endowment policy, the proceeds are paid to a revocable beneficiary of the policy who is not the owner.

Gift of Premiums

When an individual makes the premium payments on a life insurance policy or annuity contract that he or she does not own, the individual has made a taxable gift to the owner in an amount equal to the premium paid, subject to the $15,000 annual exclusion. Gift of Premiums Example: If Larry makes a premium payment on a policy owned by Kelley on her own life and under which Jay is the beneficiary, Larry has made a gift to Kelley in the amount of the premium payment. Similarly, premiums paid by an insured are gifts, if the insured has no incidents of ownership in the policy and proceeds of the policy are payable to a beneficiary other than his or her estate. Premiums paid by a beneficiary on a policy that he or she owns are not gifts.

Medical insurance benefits

are employer-provided or self-insured. The employer-provided medical expense insurance benefits are not taxable income for the employee. Benefits to highly compensated employees may be taxable, if the plan discriminates in favor of such individuals under self-insured medical expense reimbursement plans.

Generation-Skipping Transfer Tax (GST)

ensures that wealthy persons will pay transfer taxes and not avoid them, when the property transferred to their grandchildren skips taxation in their children's generation. The GST tax exemption is $11,580,000 in 2020.

Form 709

gift taxes - The gift can be considered as made one-half by an individual and one-half by his/her spouse if he/she files a gift tax return to show that the couple agree to use gift splitting. He/she must file a Form 709, United States Gift Tax Return, even if half of the split gift is less than the annual exclusion.

IRC Section 1035(a)

Existing life insurance policies and annuity contracts can be exchanged for new policies and contracts with different insurance companies as a tax-free exchange. This is permitted by IRC Section 1035(a) as a like-kind exchange if the current owner is named the new owner of the policy or annuity contract.

Select the correct statement(s) regarding life insurance dividends. I. Dividends are paid on participating insurance policies. II. Dividends are paid on non-participating policies. III. Dividends received from a mutual life insurance company are not subject to federal income tax. IV. Dividends received from a mutual life insurance company are a taxable return on investment, subject to federal income tax.

I and III A dividend is an amount paid on participating insurance policies. The dividends received from a mutual life insurance company are not subject to federal income tax. The IRS views these dividends as a return of part of the premium and not as earned income.

Premiums paid by an insured are gifts if the insured: Does not own the policy and proceeds of the policy are payable to a beneficiary other than his estate. Does not own the policy but proceeds of the policy are payable to his estate. Owns the policy but proceeds of the policy are not payable to his estate. Owns the policy but wishes to pass on the proceeds of the policy to some charity.

A Premiums paid by an insured are gifts if the insured has no incidents of ownership in the policy and proceeds of the policy are payable to a beneficiary other than his or her estate. Premiums paid by a beneficiary on a policy that he or she owns are not gifts.

Death proceeds include the policy face amount and may which of the following? Any additional insurance amounts paid by reason of the insured's death. Accidental death benefits. The face amount of any paid-in-full additional insurance. The face amount of any term rider.

All of the above Death proceeds include the policy face amount and any additional insurance amounts paid by reason of the insured's death, such as accidental death benefits and the face amount of any paid-in-full additional insurance or any term rider.

Modified Endowment Contracts (MECs)

Any life insurance contract sold after June 21, 1988, that fails to pass the test instituted by the Technical and Miscellaneous Revenue Act of 1988 (TAMARA) will be classified as a Modified Endowment Contract (MEC). The test is called the seven-pay test and was created by Congress to discourage using life insurance with high premiums as an investment. The test compares the premiums paid for the policy during the first seven years with seven annual net level premiums for a seven-pay policy. Basically, people were contributing excess premiums to build up the cash value quickly and then using it as a source of tax-free loans. Currently, people who decide to use their life insurance as a place to accumulate and then withdraw funds risk having it treated as a MEC and incurring negative income tax ramifications such as funds being subject to Last In-First Out (LIFO) treatment and a 10% penalty that applies on any taxable gains withdrawn before age 59½. However, the death benefit from a MEC will remain income tax-free to the beneficiary.

Gift-Splitting example

As part of their estate planning, Mr. and Mrs. Hall, begin to make gifts to their children. Under current rules, as a married couple, they can gift $30,000 ($15,000 x 2) to each of their three daughters, for a total of $90,000 ($30,000 x 3) a year.

Disability Income Insurance Taxation Example:

Assume that John works for ABC Incorporated, that the yearly premium for disability coverage is $2,000, and that John receives $15,000 of disability benefits for the year. What portion of the premium is deductible and what portion of the benefit received is taxable? Scenario 1: If ABC Incorporated pays 100% of the $2,000 premium, John does not report this $2,000 as income and the company is able to deduct this amount as an expense. Because John did not pay any of the premiums, the entire $15,000 of the benefit received is taxable to him as ordinary income. Scenario 2: If ABC Incorporated pays 0% of the $2,000 premium, John does not report this $2,000 as an expense against his taxes. Because John paid the entire premium, the $15,000 of the benefit received is tax-free. Scenario 3: If ABC Incorporated pays 80% of the $2,000 premium and John pays 20%, John does not report $1,600 of the premium paid as income or report the $400 paid as an expense against his taxes and the company is able to deduct the $1,600 amount as an expense. Because the company paid 80% of the premium, John will report $12,000 of the benefit received (calculated as $15,000 x 80%) as ordinary income. Because John paid 20% of the premium, $3,000 of the benefit received (calculated as $15,000 x 20%) is tax-free.

Under Section 1035(a), no gain or loss shall be recognized on the exchange of the following insurance policies EXCEPT: An annuity contract to an annuity contract. An annuity contract to life insurance contract. A life insurance contract for an endowment contract. An endowment contract for an annuity contract.

B Under Section 1035(a), no gain or loss shall be recognized on the exchange of the following insurance policies: A contract of life insurance for another contract of life insurance or for an endowment or annuity contract; or A contract of endowment insurance (A) for another contract of endowment insurance which provides for regular payments beginning at a date not later than the date payments would have begun under the contract exchanged, or (B) for an annuity; or An annuity contract for an annuity contract.

Each of the following are tax characteristics associated with Long-Term Care insurance (LTCi) EXCEPT: Qualified LTCi premiums are deductible as an itemized deduction to the extent they collectively exceed 7.5% of the taxpayer's AGI. Self-employed individuals who are sole proprietors can deduct LTC insurance premiums up to 50% of the premium. Employer contributions to an employee's LTC premium are excluded from taxable income of the employee. Benefits paid by per diem-based LTCi policies are tax-free up to a specified amount that annually adjusts for inflation.

B Self-employed individuals who are sole proprietors can deduct LTC insurance premiums up to 100% of the premium.

The value for estate tax purposes is the fair market value of the property at I. the date of death II. six months after death Neither I nor II II only Both I and II I ony

C The value for estate tax purposes is the fair market value of the property at the date of death or, if a lower estate value would result (e.g., due to investment losses), six months after death, known as the alternate valuation date.

Assume that Julia works for XYZ Incorporated and that the yearly premium for disability coverage is $6,000, paid entirely by XYZ, Inc. Julia is unable to work due to a chronic illness and receives $25,000 of disability benefits for the year. Choose the tax treatment and character of the disability benefits to Julia. $25,000 tax-free $6,000 tax-exempt, $19,000 ordinary income $19,000 ordinary income $25,000 ordinary income

D If XYZ Incorporated pays 100% of the $6,000 premium, Julia does not report this $6,000 as income and the company is able to deduct this amount as an expense. Because Julia did not pay any of the premiums, the entire $25,000 of benefit received is taxable to him as ordinary income.

Disability income insurance taxation:

Disability income insurance for employees are generally tax-deductible by the employer and are not taxable income to the employee. Employee contributions, on the other hand, are not tax-deductible by the employee.

Life Insurance

Employer Premiums: Included in employee's gross income (except for limited exclusion applicable to group term life insurance). Premiums deductible by employer (assuming employer is not the beneficiary). Employer Benefits: Excluded from gross income. Employee Premiums: Not deductible. Employee Benefits: Excluded from gross income.

T or F: If an owner gifts their life insurance policy to another person, or transfers their policy into an Irrevocable Life Insurance Trust (ILIT) within three years of their death, the death benefit proceeds will also be excluded in their gross estate.

F If an owner gifts their life insurance policy to another person, or transfers their policy into an Irrevocable Life Insurance Trust (ILIT) within three years of their death, the death benefit proceeds will also be included in their gross estate.

When is federal estate taxes due?

Generally, a federal estate tax return must be filed and any estate taxes paid within nine months of the death of any U.S. citizen or resident who leaves a gross estate of more than a specified exempted amount. The exempted amount in 2020 is $11,580,000. An extension of up to 10 years may be granted for payment of taxes by the IRS for "reasonable cause," including those taxes associated with certain closely held businesses. The federal estate tax is a graduated tax, starting at 18 percent and building to a 40 percent marginal rate for taxable amounts over $11,580,000 in 2020. The gross estate, the starting point for estate tax computation, consists of the value of the decedent's interest in all property. Allowable deductions are then subtracted from the gross estate, which results in the taxable estate. However, the unified credit is a tax credit that can be applied to offset the taxable estate.

Gift of Insurance Contract

If an insured irrevocably assigns all rights in an existing insurance contract for less than an adequate consideration, a gift of the contract is made, and gift taxes may be due. Of course, if the owner receives an adequate consideration for the transfer, it is a sale, not a gift. If the owner gifts an existing contract upon which premiums remain to be paid, such as a whole life insurance policy, the value of the gift is the policy's fair market value, which is its replacement cost. If a comparable contract is not ascertainable, the fair market value equals the interpolated terminal reserve plus the value of unearned premiums and any accumulated dividends, and less any policy indebtedness. The reserve value, not the cash surrender value, is considered, although the difference often is negligible except in the early policy years. If the policy owner gifts a single-premium or paid-up life insurance policy or annuity, the value of the gift equals the replacement cost of the contract, which is the single premium that an insurance company would charge for a comparable contract issued at the insured's/annuitant's attained age. A comparable contract is one providing payments of the same amount. With term life insurance policies, the gifted amount is the value of the unused premium. If a new policy was bought for another person the gift is the gross premium paid by the donor.

Medical Insurance Benefit

In the case of employer-provided medical insurance benefits, employers can deduct medical and health insurance premiums. Benefits to employees are not included in their gross income, therefore they are not taxable to an employee unless the benefits exceed the actual medical expenses incurred. In self-insured accident and health plans, the employer pays an employee's medical expenses directly instead of paying for insurance premiums. Benefits to highly compensated employees may be taxable if the plan discriminates in favor of such individuals. Highly compensated employees must report any medical reimbursements they receive in their gross income if these same reimbursements are not made available to other employees. As health insurance benefits realistically are not available for other types of consumption or for savings, it is logical that they should not be subject to a tax levied on net income. Another important policy justification for the health benefit exclusion is to encourage the purchase of private insurance to minimize the role of government in bearing the burden of health care costs.

The value for estate tax purposes is the fair market value of the property at the date of death or, if a lower estate value would result (for example, due to investment losses), six months after death, known as

he alternate valuation date.

The Gift Tax Law benefits

include gift-splitting privileges, deductions, gift of life insurance, gift of insurance contracts, gift of premiums, and gift of proceeds.

Crummey v. Commissioner., No. 21,607 (9th Cir. 25 June 1968))

which create a present interest for beneficiaries. A Crummey power allows trust creators (grantors) to temporarily treat property with a future interest as a gift of present interest. This enables the donor to use annual exclusions for each beneficiary to reduce the gift tax value of the policy transferred into the trust, and to reduce any taxable premium amounts that are transferred into the trust annually. Life insurance policies that are transferred into an irrevocable trust are treated differently. The beneficiaries of the trust do not have a present interest in the policy until the insured dies. Therefore, the gift tax value of the policy cannot be reduced by annual exclusions for each beneficiary in the trust. That is why many irrevocable life insurance trusts (ILITs) contain "Crummey" provisions.

Under Section 1035(a), no gain or loss shall be recognized on the exchange of the following insurance policies:

- A contract of life insurance for another contract of life insurance or for an endowment or annuity contract; or - A contract of endowment insurance (A) for another contract of endowment insurance which provides for regular payments beginning at a date not later than the date payments would have begun under the contract exchanged, or (B) for an annuity; or - An annuity contract for an annuity contract.

However, financial planners need to consider issues in a 1035 exchange such as:

- New expenses and commissions on the new policy. - Early surrender charges paid on the old policy. - Higher premium on the new policy due to older age when issued. - Higher premium as health has declined since the issue of the original policy being exchanged. - New contestability period: a two-year period from the issuance of the new policy during which the insurance company could challenge a death claim based upon misstatement on the application. - Tax consequences on surrendering an existing policy that has an outstanding loan.

Accelerated Death Benefits regulations provide that payments meeting a three-part test will be identified as a qualified accelerated death benefit, in which case the benefits may be received on the same tax-free basis applying to conventional death benefits. These cases include:

- The insured must be terminally ill. - The reduction of the remaining face value of coverage is limited. - The cash value of the remaining death benefit may not be reduced.

There are exceptions to the transfer for value rule which will not cause the death benefit to be subject to income taxes at the insured's death. This occurs when the insurance policy is transferred to the following individuals or entities.

- The insured. - The insured's partner. - The transferor's spouse incident to a divorce. - A new owner who takes the transferor's basis in the contract. - To a partnership in which the insured is a partner. - To a corporation in which the insured is a shareholder or officer

The federal gift tax is incurred if: A mother gifts a teddy bear worth $10 to her son on his birthday. If one sends a Christmas card worth $2 to a friend for Christmas. If a mother gifts her daughter a watch worth $16,000, in a specific year. If a mother gifts her son a watch worth $9,000, in a specific year.

3 The federal gift tax law is not aimed at the usual exchange of gifts associated with birthdays, holidays and similar occasions. The law permits a donor to make a gift without tax by excluding the first $15,000 (2021) of outright gifts in any one specific year to any one recipient.

BE CAREFUL: 2 year 1035 exchange rule

A distribution occurring within 24 months is deemed to be abusive by the IRS, and multiple contracts would be treated as one contract when determining taxable gain and the tax-free return of basis. Exceptions to this two year rule include distributions made for unexpected events such as divorce or unemployment.

Gift of Life Insurance and Annuities

A life insurance policy is especially well suited as a gift. Gifts are also made of annuities. Gifts of life insurance and annuities include gifts of the contract itself, gifts of premium payments, and gifts of policy proceeds. Each of these is dealt with separately for valuation.

Transfer-for-value example

Assume that Mother is the owner and the insured on a policy with a death benefit of $400,000, an annual premium of $7,300, and a cash value of $75,000. Mother sells this policy to Daughter (the beneficiary) for the $75,000 cash value. When Mother dies three years later then Daughter, as owner/beneficiary, will receive the $400,000 death benefit amount of the policy. The $75,000 amount that Daughter paid for the policy plus the annual premium, which we will assume is $21,900 (calculated as 3 yearly payments of $7,300), is her adjusted basis in the policy of $96,900. The difference between the death benefit amount of $400,000 that Daughter received and her adjusted basis of $96,900 in the policy is $303,100 and is subject to income taxes at her marginal tax rate.

Define Incidents of ownership

Incidents of ownership include any economic benefit in a life insurance policy. A life insurance policy owner has incidents of ownership in the policy that may include the right to borrow against the policy, assign or transfer the policy, receive cash values and dividends or change the beneficiaries. Retaining any incidents of ownership in a policy causes the death benefit to be included in the insured's estate, which may be subject to estate tax. Inclusion occurs even if the policy is transferred to a new owner or to a trust more than three years before the insured's death, if any incidents of ownership are retained.

The taxation of life insurance:

Premium payments for individually purchased life insurance are not deductible from a person's federal income tax. However, when the beneficiary receives the proceeds of a life insurance policy, no federal income tax applies to this amount. Death benefit amounts are included in the owner-insured's estate, unless gifted to others more than three years before the owner's death, or transferred into an irrevocable life insurance trust more than three years before the owner's death.

T or F: If the insured withdraws the savings value of the insurance and if this value exceeds the insured's adjusted basis, the excess is subject to federal income tax in the year of the withdrawal.

True if the insured withdraws the savings value of the insurance and if this value exceeds the insured's adjusted basis, (premiums paid less dividends received), the excess is subject to federal income tax in the year of the withdrawal.

The general rule under the clause of living benefits is

if the insured withdraws the savings value of the insurance and if this value exceeds the insured's adjusted basis, (premiums paid less dividends received), the excess is subject to federal income tax in the year of the withdrawal.

Death proceeds

include the policy face amount and any additional insurance amounts paid by reason of the insured's death, such as accidental death benefits and the face amount of any paid-in-full additional insurance or any term rider. Proceeds must be paid by reason of the death of the insured, which means that the insured's death must have caused the maturity of the contract.

A present interest

is a situation in which the recipient must have possession or enjoyment of the property immediately. An example is a gift of cash or property that can be used immediately by the recipient.

Unified credit

is a tax credit that can be applied to offset estate and gift taxes. In 2020, the unified credit amount is $4,577,800.

The applicable credit or unified credit

is a tax credit that can be applied to offset estate and gift taxes. The practical effect of the unified credit is to eliminate transfer taxes on total lifetime and testamentary transfers. For example, the unified credit of $4,505,800 offsets gift and estate taxes up to $11,580,000. The transfer tax on $11,580,000 is $4,505,800, so once the credit is subtracted from the tentative tax, the tax liability (which is the amount owed) is zero.

The Federal Estate Tax

is a tax on a person's right to transfer property on death. It is calculated on the value of the person's property, and plays a key role in large estates. This tax is for taxable estates in excess of $11,580,000 in 2020.

The Gift Tax Law

is calculated by adding all the donor's lifetime taxable gifts. A unified rate schedule to the total taxable gifts is applied to derive the tentative tax. The unified tax credit is subtracted from this, to yield the gift tax payable in the current period.

The Federal Gift Tax

is imposed upon a living donor for the right to transfer property to another person. However, an annual exclusion of up to $15,000 per person, gift-splitting and use of the gift tax applicable credit can reduce the gift tax liability of taxable gifts.

Federal Gift Tax Law

is imposed upon the right to transfer property to another person, and does not include the ordinary exchange of gifts associated with occasions like birthdays and holidays.

The exclusion is not available for gifts of a future interest in property

that is, any interest in property that does not pass into the recipient's possession or enjoyment until some future date. This would occur if a trust beneficiary can only receive the remainder interest in the trust corpus, not an immediate income interest, or if the beneficiary would not receive distributions from a trust until a later time.

Each of the following are characteristics of a life insurance policy that becomes a Modified Endowment Contract (MEC) EXCEPT: The death proceeds received above the adjusted basis (premiums paid - dividends) are taxable. Any policy loans or withdrawals will have Last In-First Out (LIFO) treatment. A 10% penalty is applied to any amounts withdrawn from the policy that exceed adjusted basis for individuals younger than age 59 ½. The premiums paid for the policy during the first seven years exceeded seven annual, net level premiums.

1 People who decide to use their life insurance as a place to accumulate and then withdraw funds risk having it treated as a MEC and incurring negative income tax ramifications such as funds being subject to Last In-First Out (LIFO) treatment and a 10% penalty that applies on any taxable gains withdrawn before age 59½. However, the death benefit from a MEC will remain income tax-free to the beneficiary.

Under Section 1035(a), no gain or loss shall be recognized on the exchange of a life insurance policy to which of the following: (Select all that apply) Life insurance contract Endowment contract Annuity policy Appreciable property

1, 2 & 3 Under Section 1035(a), no gain or loss shall be recognized on the exchange of the following insurance policies: - A contract of life insurance for another contract of life insurance or for an endowment or annuity contract; or - A contract of endowment insurance (A) for another contract of endowment insurance which provides for regular payments beginning at a date not later than the date payments would have begun under the contract exchanged, or (B) for an annuity; or - An annuity contract for an annuity contract.

If Brashad gives $9,000 to Jamal and $11,000 to Omar, then he can exclude _____________ for gift tax purposes. $15,000 $20,000 $30,000 $11,000

20k The $15,000 gift tax exclusion is the maximum gift tax-free amount, applied on a per person basis. A $9,000 gift to Jamal and a $11,000 gift to Omar are each below the $15,000 limit. Therefore, a total of $20,000 ($9,000 + $11,000) in gifts are tax-free to Brashad.

The annual exclusion amount applies to ________________. testamentary transfers future interest gifts bequests present interest gifts

4 The annual exclusion is available only when the gift is one of a present interest. A present interest is a situation in which the recipient must have possession or enjoyment of the property immediately. An example is a gift of cash or property that can be used immediately by the recipient.

Each of the following is an available deduction from the gross estate to arrive at the adjusted gross estate EXCEPT: Attorney fees deducted on the estate's income tax return Debts of the decedent Casualty or theft losses Funeral and administration expenses

A Allowable deductions are subtracted from the gross estate, which results in the adjusted gross estate. Allowable deductions include funeral and administration expenses, debts of the decedent, certain taxes, and casualty or theft losses. Attorney fees are an available deduction from the gross estate, however, if the executor of the estate deducted the expenses on the estate's income tax return (Form 1041), the same expenses cannot also be deducted on the federal estate tax return (Form 706) to determine the adjusted gross estate.

Assume Noreen names her daughter, Adrienne, the beneficiary of her $7 million life insurance policy and transfers the policy to her five years before her death. If Noreen retained the right to borrow against the policy, the $7 million death benefit will be included in which estate? Noreen's Adrienne's The contingent beneficiary's None of these

A At Noreen's death the $7 million in death proceeds are included in Noreen's estate since she retained the right to borrow against the policy. Although Noreen transferred the policy to Adrienne more than three years before her death, this incident of ownership causes the death benefit to be included in Noreen's estate.

If an owner gifts their life insurance policy to another person or transfers their policy into an Irrevocable Life Insurance Trust (ILIT) within ___________of their death, the death benefit proceeds will be included in their gross estate. 3 years 2 years 6 months 1 year

A If an owner gifts their life insurance policy to another person or transfers their policy into an Irrevocable Life Insurance Trust (ILIT) within three years of their death, the death benefit proceeds will be included in their gross estate.

The _____________ can be applied to offset the taxable estate. unified credit generation skipping transfer tax adjusted gross estate annual exclusion

A The gross estate, the starting point for estate tax computation, consists of the value of the decedent's interest in all property. Allowable deductions are then subtracted from the gross estate, which results in the taxable estate. The unified credit is a tax credit that can be applied to offset the taxable estate.

Generation-Skipping Transfer Tax Example:

A grandmother may gift property directly to her granddaughter rather than to her son. In the absence of the GST, this gift could avoid all transfer taxes that otherwise might have been incurred if the transfer were first to her son, and then by the son to the granddaughter. The amount of the GST tax is a function of the property value transferred and the applicable tax rate. For 2020, a total of $11,580,000 may be transferred during his or her lifetime, free of GST tax. If the spouse joins in the transfer, the lifetime exemption is doubled through gift splitting. The value of transferred property in excess of the exemption is subject to the maximum prevailing transfer tax rate of 40%. The GST tax is of little importance to persons of modest wealth, but those with greater wealth could incur substantial taxes under this provision.

Gift Tax Law

A lifetime gift to an individual incurs a federal gift tax generally at the same rate as the federal estate tax. For 2020, the maximum amount of lifetime gifting is reunified with the estate tax at $11,580,000. Taxable gifts are amounts that exceed $15,000, the annual exclusion amount in 2020. A person could gift more than $11,580,000 in his or her lifetime without incurring a gift tax by gifting in increments of $15,000 (to an unlimited number of individual donees in a given year) because annual exclusion amounts are not taxed.

Allowable deductions are subtracted from the gross estate, to arrive at the adjusted gross estate include which of the following? (Select all that apply) Funeral and administration expenses Debts of the decedent Certain taxes Casualty or theft losses Unrealized appreciation of property

A, B, C & D Allowable deductions are subtracted from the gross estate, which results in the adjusted gross estate. Allowable deductions include funeral and administration expenses, debts of the decedent, certain taxes, and casualty or theft losses.

What is the Adjusted Gross Estate

Allowable deductions are subtracted from the gross estate, which results in the adjusted gross estate. Allowable deductions include funeral and administration expenses, debts of the decedent, certain taxes, and casualty or theft losses. The taxable estate is calculated by subtracting allowable deductions from the adjusted gross estate. These deductions include bequests to the surviving spouse, which qualify for the marital deduction, and bequests to qualified charities, which receive a charitable deduction. Another deduction is taken for state death taxes paid. A decedent who is the owner/insured of a life insurance policy will have the death benefit proceeds included in his or her gross estate at death. If the spouse is named the beneficiary of the policy, the decedent's marital deduction would offset the death benefit amounts, and the proceeds would avoid inclusion in the decedent's taxable estate. If a charity is named the beneficiary of the policy, the decedent's charitable deduction would offset the death benefit amounts, and the proceeds would not be included in the decedent's taxable estate. Both the surviving spouse and the charity would receive the death benefit proceeds income tax-free.

Living Benefit Taxation Example:

Bill purchased a whole life insurance policy 35 years ago when he was 25 years old. He decides to retire at age 60 and he withdraws the cash value of his life insurance to buy a recreational motor home. Assume Bill's total premiums ($50,000) less dividends he received ($21,000) equal $29,000. If Bill withdraws $35,000 in cash value, $6,000 ($35,000 - $29,000) is subject to tax. For the past 35 years, Bill has not had to report the interest income on the savings value of the policy. When the withdrawal is made, however, the excess of the cash value over his adjusted basis is subject to the income tax at ordinary rates.

Partial 1035 Exchange Taxation Example:

Building on the previous example, if Lauren wanted to withdraw $50,000 from her annuity contract she would be taxed on the $50,000 at ordinary income rates. Instead, Lauren does a 50% partial 1035 exchange and transfers $75,000 from Company A's contract (valued at $150,000) into a new contract. Each contract will now have $75,000 and a cost basis of $50,000 which is ½ of her original basis of $100,000. When Lauren withdraws $50,000 now from Company A's contract, she will only have a taxable gain of $25,000.

Medical and Health Insurance

Employer Premiums: Premiums not included in employee's gross income. Employer Benefits: Excluded from employee's gross income except when benefits exceed actual expenses. Employee Premiums: Premiums, together with other eligible medical expenses deductible as medical expense subject to 7.5% of AGI limitation. Employee Benefits: Excluded from gross income.

How is health insurance taxed?

Employers can deduct medical and health insurance premiums. Individually paid premiums may be included in determining the itemized deduction for unreimubursed medical expenses.

How is Long-term care insurance taxed?

In general, benefits are excluded from taxable income. Insurance premiums and out-of-pocket spending for LTC services qualify as medical expense deductions, and are 100% deductible up to specified age limits. It is easy to conclude that health insurance benefits utilized to pay for an operation or a physician's examination should, as a matter of public and tax policy, be excluded from income. However, uncertainty has existed about the tax treatment of Long Term Care (LTC) mainly because LTC involves a combination of services, some of which are health care related and others of which appear more like personal items (e.g., room and board in an assisted living facility). This uncertainty was resolved for certain types of policies with the enactment of Health Insurance Portability and Accountability Act. The legislation clarified that qualified LTC costs and benefits generally will be treated the same way as other health costs and benefits. If policies and insurers follow the consumer protection standards included in the law, such policies receive the following tax treatment: In general, benefits are excluded from taxable income. Benefits paid by per diem-based policies are tax-free up to $380 per day in 2020. Per diem amounts above $380 can be excluded from income if expenses are equal or greater than this amount. Insurers must report to the IRS the amount of LTC insurance benefits paid. Insurance premiums and out-of-pocket spending for LTC services qualify as eligible medical expenses in determining an itemized deduction for unreimubursed medical expenses. Qualified long term care insurance premiums, up to the stated annual limit based on age, together with other eligible medical expenses, are deductible as an itemized deduction to the extent they collectively exceed 7.5% of the taxpayer's AGI. Self-employed individuals who are sole proprietors can deduct LTC insurance premiums up to 100% of the premium. Employer contributions to an employee's LTC premium are excluded from taxable income of the employee. It is important to note that LTC insurance cannot be offered as part of an employer's cafeteria plan.

Section 1035 Exchange Example:

Lauren bought a deferred annuity from Company A for $100,000 and is listed as the owner. The current value of the annuity contract is $150,000. Lauren wishes to purchase a better annuity contract from Company B. If Lauren surrenders the annuity from Company A to buy a new $100,000 annuity from Company B she will owe income tax on the gain of $50,000. With a 1035 exchange, Lauren can exchange her current annuity for Company B's annuity without owing taxes on the gain. Her cost basis in Company B's new annuity contract is the same as her previous basis in Company A's contract of $100,000.

Examples of incidents of ownership

Now, assume instead that six years ago John transferred all ownership rights in the life insurance policy to his wife Abigail, not to Fred, and that he died this year. In this case, the life insurance proceeds would not be included in John's estate because he did not own the policy or have any incidents of ownership at his death, and he had transferred the policy more than three years before he died. If Abigail had died before John, however, then the value of the policy at the time of her death - the replacement cost value - would be included in her estate. Fred as beneficiary would owe no federal income tax on the proceeds he received, but his mother (as policy owner who is not the insured) would have given him a $1 million gift of the proceeds. This complication is one reason why people often use irrevocable trusts to own life insurance as part of their estate plan. If, however, the gross estate is below the lifetime applicable exclusion amount, there will be no federal income tax or estate tax due, and therefore, perhaps no need to create an irrevocable life insurance trust (ILIT).

Define Generation-Skipping Transfer Tax and skip persons?

The generation-skipping transfer tax (GST) is levied when a property interest is transferred to persons who are two or more generations younger than the transferor. The transferor for property subject to the federal estate tax is the decedent and, for property subject to the gift tax, the transferor is the donor. The GST tax is intended to ensure that transfer taxes are paid by wealthy persons who might otherwise avoid a generation of transfer taxes by passing their property to heirs beyond those of the next generation, referred to as skip persons. The tax is in addition to any federal estate or gift taxes owed because of the transfer.

gross estate

the starting point for estate tax computation, is composed of the value of the decedent's interest in all property. There are some exceptions. Outright ownership of property is not required for its value to be included in the gross estate. The IRS may impose a penalty of 10% to 30% of the amount of tax owed if property is found to be undervalued. Decedents who are owners of life insurance policies, or have any incidents of ownership in life insurance policies, will have the death benefit included in their gross estate at death. If an owner gifts their life insurance policy to another person, or transfers their policy into an Irrevocable Life Insurance Trust (ILIT) within three years of their death, the death benefit proceeds will also be included in their gross estate. A decedent who owns a life insurance policy on another person's life, will have the replacement cost value of that policy included in their gross estate at death. A person who is an owner of a policy but is not the insured, can transfer that policy any time prior to death, and the value will not be included in their gross estate at death. The difference from the example above is that the owner/insured is subject to the 3 year rule in policy transfers, while the owner who is not the insured is NOT subject to the 3 year rule for policy transfers.

Prior to the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA 2001) and up through 2003

the unified credit available for taxable transfers made either during lifetime or after death was identical. In 2004, the applicable credit began to increase for estate tax purposes, but for gift tax purposes it stayed at a constant $345,800 (tax on an asset equivalent value of $1 million). Beginning in 2011, the gift tax and estate tax rate schedule is unified again.