CSR 486 Ch 11

Olivia's dad, Benson, died on August 10 of this year. Six years ago, Benson had gifted ownership of a paid-up $1,000,000 whole life insurance policy on his life with a replacement value of $150,000 and an adjusted basis of $100,000 to Olivia. If Olivia, as designated beneficiary, receives the death benefit of the life insurance policy this year, how much will be taxable to her? A)$0. B)$50,000. C)$100,000. D)$1,000,000.

$0. Rationale A gift of a life insurance policy is not a transfer for valuable consideration and as such the death benefit, payable by reason of Benson's death, is not included in Olivia's taxable income.

Four years ago, Rhett gave a life insurance policy with a $750,000 death benefit to his daughter, Marcelle. At the time of the gift, the value of the life insurance policy was $65,000, and Rhett paid $10,000 in federal gift tax. Rhett unexpectedly died this year. What amount will be included in Rhett's federal gross estate related to this life insurance policy? A)$0. B)$10,000. C)$65,000. D)$750,000.

A)$0. Rationale Because Rhett died more than three years after the gratuitous transfer of the life insurance policy, Rhett's federal gross estate would not include any amount related to this life insurance policy.

Mariska's father died last month and she is the listed beneficiary on his insurance policy. Mariska has contacted the insurer and has requested a lump-sum payment of the death benefit of the life insurance policy. Which of the following statements regarding this lump-sum payment is true? A)When ?Mariska receives the lump-sum payment of the death benefit from the insurer, the payment will be taxable to the extent of any interest earned between the date of death and the payment to Mariska.. B)Because Mariska has elected a lump-sum payment of the death benefit, she will actually receive a payment less than the face value of the policy. C)Had Mariska elected the life annuity, each payment would have been excluded from her gross income. D)Mariska could have elected to leave the death benefit on deposit with the insurer and continue the tax-deferred growth of the policy.

A)When ?Mariska receives the lump-sum payment of the death benefit from the insurer, the payment will be taxable to the extent of any interest earned between the date of death and the payment to Mariska.. Rationale When Mariska receives the lump sum death benefit, she will also receive fully taxable interest on the death benefit that accrued from the time of her father's death to the date the insurer paid Mariska. Option b is a false statement. Option c is incorrect because if Mariska had elected the annuity option, a portion of each annuity payment would have been taxable as interest income and the remaining portion of the payment would have excluded from Mariska's taxable income. Option d is incorrect because if Mariska had chosen to leave the death benefit on deposit with the insurer, she would have to include the earnings on the death benefit in her taxable income each year.

Which of the following is not considered an incident of ownership? A)The right to change the beneficiary of a life insurance policy. B)The insured making cash gifts to the owners of the life insurance policy of the premium amount. C)The right to take loans against the cash value of the life insurance policy. D)A provision in an ILIT that directs the trust to pay the federal estate taxes of the insured.

B)The insured making cash gifts to the owners of the life insurance policy of the premium amount. Rationale If the insured makes cash gifts to the owners of the life insurance policy equal to the premium amount it is not considered an incident of ownership. All of the other options would be considered an incident of ownership.

Who has the right to surrender a life insurance policy for its cash surrender value? A)The insured of the life insurance policy. B)The owner of the life insurance policy. C)The beneficiary of the life insurance policy. D)The insurer of the life insurance policy.

B)The owner of the life insurance policy. Rationale The owner of a life insurance policy is the only party to a life insurance policy who can surrender a life insurance policy for its cash surrender value.

Myles is the owner of a paid-up whole life insurance policy on his own life. All of the following statements are correct except: A)Myles has title of the whole life insurance contract. B)Myles can borrow against the cash value of the whole life insurance policy. C)The death benefit of the whole life insurance policy will be included in Myles's federal gross estate. D)If Myles gifts the whole life insurance policy to his son, the value for gift tax purposes is the sum of the policy's interpolated terminal reserve plus any unearned premium.

D)If Myles gifts the whole life insurance policy to his son, the value for gift tax purposes is the sum of the policy's interpolated terminal reserve plus any unearned premium. Rationale Because it is a paid-up whole life insurance policy, the value for gift tax purposes is the replacement cost of the policy. All of the other statements are true.

Many individuals who have been diagnosed with terminal illnesses sell their life insurance policies to viatical settlement providers. Which of the following statements is true regarding the transfer of a policy from an individual with a terminal illness to a viatical settlement provider? A)If the individual dies within three years of the transfer, the full proceeds of the insurance policy are included in his federal gross estate. B)The individual is subject to capital gain taxes on the difference between his adjusted basis in the life insurance policy and the amount paid to him by the viatical settlement provider. C)Regardless of when the individual dies, the payment from the viatical settlement company is excluded from income tax. D)If the individual lives for more than one year after the transfer, the individual will be subject to income tax on the payment from the viatical provider.

Regardless of when the individual dies, the payment from the viatical settlement company is excluded from income tax. Rationale The IRC (Section 101(g)) excludes amounts received under a life insurance contract on the life of an insured individual who is chronically or terminally ill from the individual's gross income. There is no requirement that the individual die within a certain period of time. Option a is incorrect because the three-year rule (Section 2035) only applies to gratuitous transfers of life insurance. In this case, the life insurance policy was sold to the viatical settlement provider, and thus would not be subject to the three-year rule.

In an attempt to exclude the death benefit of a paid up $500,000 face value whole life insurance policy from his gross estate, Caesar gifted the policy to his daughter. Six months prior to the gift, Caesar had been diagnosed with a terminal illness and given a 12 month life expectancy by his doctor. Caesar died four years after the gift of the life insurance policy. What amount is included in his federal gross estate related to this whole life insurance policy? A)$0. B)$250,000. C)$500,000. D)$500,000 discounted for Caesar's six month life expectancy.

A)$0. Rationale Caesar's federal gross estate would not include any value related to this life insurance policy because he is not the owner or beneficiary of the life insurance policy at his death, and the gift was made more than three years prior to his death. An individual's federal gross estate only includes the death benefit of a life insurance policy on the insured, if the individual is the owner or beneficiary, or if there was a gratuitous transfer of the life insurance within three years of the individual's death.

Twelve years ago, Sebastian purchased a single premium $1,000,000 life insurance policy on his own life for $150,000 and named his daughter, Holly, as the sole beneficiary. Sebastian gifted ownership of the policy to Holly this year when the value of the life insurance policy was $200,000. Sebastian paid $15,000 of gift tax on the transaction. At Sebastian's death, how much of the death benefit that Holly receives will be subject to income tax? A)$0. B)$785,000. C)$800,000. D)$1,000,000.

A)$0. Rationale Even though the life insurance policy is considered a modified endowment contract, the receipt of the death benefit remains income tax free to the extent the policy had not been transferred for valuable consideration. In this case, the transfer to Holly was a gift, not a transfer for valuable consideration, so the death benefit is not subject to income tax.

Selena was recently diagnosed with stage four lung cancer. Her doctors have given her nine months to live. She has many medical expenses and needs money. If Selena sells a whole life insurance policy, with a $1,000,000 face value and a $250,000 adjusted basis to a viatical settlement provider for $350,000, how much capital gain will Selena have to recognize for income tax purposes on the sale? A)$0. B)$250,000. C)$350,000. D)$1,000,000.

A)$0. Rationale The IRC (Section 101(g)) states that amounts received under a life insurance contract on the life of an insured individual who is chronically or terminally ill may be excluded from gross income. Because her doctors expect her to die within 9 months, Selena is considered terminally ill. A terminally ill individual is a person who has been certified by a licensed health care provider as having a condition or illness that can reasonably be expected to result in death within 24 months.

Judd, age 71, has been paying the premium on a whole life insurance policy for the past 30 years. The policy has a $1,000,000 death benefit and has built up a cash value of $250,000. Judd's adjusted basis in the life insurance policy is $200,000. Which of the following statements is not correct? A)If the insurer pays ?Judd a life insurance policy dividend of $3,000, his adjusted basis in the whole life insurance policy will increase to $203,000. B)If the insurer pays ?Judd a life insurance policy dividend of $4,000, his adjusted basis in the whole life insurance policy will decrease to $196,000. C)The cash surrender value of ?Judd's whole life insurance policy would be equal to the cash value of the policy less any life insurance policy surrender charge still in effect. D)?Judd can take a loan from the cash value of the life insurance policy without suffering any income tax consequences.

A)If the insurer pays ?Judd a life insurance policy dividend of $3,000, his adjusted basis in the whole life insurance policy will increase to $203,000. Rationale Life insurance policy dividends are a return of the policy owner's adjusted basis. Any policy dividends received would decrease, not increase, the owner's adjusted basis. All other options are correct.

Which of the following statements regarding term life insurance is correct? A)The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract. B)The cash accumulation account of a term life insurance policy is invested in the bond portfolios of the insurer. C)The cash accumulation account of a term life insurance policy is invested in individual stocks selected by the insured. D)The premium of a term life insurance policy will decrease as the pure cost of life insurance increases.

A)The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract. Rationale The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract. Options b and c are incorrect because a term life insurance policy does not have a cash accumulation account. Option d is incorrect because the premium of a term life insurance policy increases as the pure cost of life insurance increases.

Jim purchased a yacht from Ronald for $200,000 seven years ago. The terms of the sale included a note of $50,000 and cash for the remaining amount. Ronald had a zero basis in the yacht. Immediately after purchasing the yacht, Jim's business began to fail and Jim could no longer make the payments. In exchange for the note, Jim gave Ronald a life insurance policy on his life with a face value of $50,000. This year, Jim died and Ronald received the death benefit as the designated beneficiary of the policy. How much of this death benefit is taxable to Ronald? A)$0. B)$50,000. C)$150,000. D)$200,000.

B)$50,000. Rationale The transfer of the life insurance policy for the note is a transfer for valuable consideration. If a life insurance policy is transferred for valuable consideration, the death benefit in excess of the transferee's adjusted basis will be subject to income tax. Ronald did not have any basis in the boat, so correspondingly, he does not have any basis in the note and must recognize gain to the extent any value is received. As such, the $50,000 death benefit received is taxable income to Ronald.

Carol and Joe, unrelated business partners, began operating a drug store in southern Florida. They funded a buy/sell agreement with a cross-purchase life insurance arrangement. Carol purchased a life insurance policy with Joe as the insured, and Joe purchased a life insurance policy with Carol as the insured. If Carol dies, which of the following is/are true?1. The death benefit of the life insurance policy on Carol's life, owned by Joe, is excluded from Carol's federal gross estate.2. The death benefit of the life insurance policy on Carol's life, owned by Joe, is included in Carol's federal gross estate if Carol own's 50% or more of the stock of the drug store.3. The value of the life insurance policy on Joe's life, owned by Carol, is included in Carol's federal gross estate.4. The death benefit of the life insurance policy on Carol's life, owned by Joe, is included in Carol's federal gross estate. A)1 only. B)1 and 3. C)1, 2, and 3. D)1, 2, 3, and 4.

B)1 and 3. Rationale Option 1 is correct because Carol's federal gross estate will not include the death benefit of the life insurance policy on her life owned by Joe because Carol does not possess any incidents of ownership in the policy. Option 3 is correct because when an individual dies owning a life insurance policy on the life of another person, the value of the life insurance policy will be included in her federal gross estate. Option 2 is incorrect because Carol's ownership in the drug store does not change the fact that Carol does not possess any incidents of ownership in the life insurance policy on her life, owned by Joe. The death benefit of a life insurance policy on Carol's life would only be included in Carol's federal gross estate if she possessed any incidents of ownership in the life insurance policy. Option 4 is incorrect because Carol does not possess any incidents of ownership in the policy.

Which of the following statement(s) is/are correct regarding buy-sell arrangements?1. Entity purchase arrangements increase the income tax basis for some surviving owners upon the death of another owner. 2. Cross-purchase arrangements increase the income tax basis for all surviving owners the death of another owner. A)1 only. B)2 only. C)Both 1 and 2. D)Neither 1 nor 2.

B)2 only. Rationale Entity arrangements do not increase the income tax basis of surviving owners.

Which of the following statements regarding universal life insurance policies is true? A)As long as the premium of a universal life insurance policy is paid, the insurer guarantees that the life insurance policy will remain in force. B)A universal life insurance policy will be cancelled if the pure cost of insurance protection increases and the cash accumulation account does not have the funds to pay the additional cost. C)Funds within the cash accumulation account of a universal life insurance policy cannot be used to pay the policy premium. D)A universal life insurance policy allows the insured to select the cash accumulation account investments.

B)A universal life insurance policy will be cancelled if the pure cost of insurance protection increases and the cash accumulation account does not have the funds to pay the additional cost. Rationale A universal life insurance policy is similar to a term life insurance policy but with a cash accumulation account attached to it. In the initial years of the policy, the premium paid is in excess of the pure cost of the insurance, and the excess is deposited into the cash accumulation account. In the later years of the life insurance policy, the pure cost of the insurance will increase, but the insured will continue to pay the same premium. Funds within the cash accumulation account will pay any difference between the pure cost of the insurance and the premium paid by the owner. However, if the cash accumulation account does not have the funds to pay the difference, the life insurance contract will lapse. Only a whole life insurance policy will remain in force at all times when the pure cost of the insurance is in excess of the premium paid. Option a is incorrect because the universal life insurance policy will lapse if the policy premium is not paid and the cash accumulation account does not have the funds necessary to pay the policy premium. Even if the policy premium is paid, the universal life insurance policy will also lapse if the cash accumulation account does not have the funds to pay the excess pure insurance cost. Option c is incorrect because the cash accumulation account can be used to pay the policy premium. Option d is incorrect because the insured does not select the investments for the cash accumulation account.

As part of his employee benefit package, Hugo's employer provided him with a $50,000 term life insurance policy. Hugo named his wife, Nina, as the sole beneficiary of the life insurance policy. Which of the following statements is true with regard to this life insurance policy? A)Because the term insurance policy is part of a group term life insurance policy, the death benefit payable to Nina is considered taxable income. B)At Hugo's death, the death benefit payable to Nina will be included in Hugo's federal gross estate. C)Hugo cannot change the beneficiary of the life insurance policy without Nina's prior written approval. D)If Nina dies before Hugo, her federal gross estate will include the life insurance policy death benefit.

B)At Hugo's death, the death benefit payable to Nina will be included in Hugo's federal gross estate. Rationale The death benefit of the life insurance policy will be included in Hugo's federal gross estate because Hugo was the owner of the life insurance policy and had the right to change the designated beneficiary of the policy. Option a is incorrect because the death benefit payable from a policy issued under a group term life insurance policy is treated just like the death benefit payable from any other life insurance policy. As long as the policy has not been transferred for valuable consideration, the beneficiary will receive the death benefit without any income tax ramifications. Option c is incorrect because the owner of the policy can change the beneficiary designation without any authorization from the current beneficiary. Option d is incorrect because the beneficiary of a life insurance policy does not have any right to the death benefit until the insured has died. In this case, Nina, the beneficiary, has died before the insured on the policy, Hugo, so Nina will not include any amount related to the life insurance policy in her federal gross estate.

Raphael is the owner of a variable life insurance policy on his life. His wife, Clarice is the designated beneficiary. Which of the following statements is correct? A)If Clarice dies before Raphael, Clarice must include the value of the life insurance policy in her federal gross estate. B)At Raphael's death, the variable life insurance policy death benefit will be paid to Clarice. C)When the beneficiary of a life insurance policy is the spouse of the insured/owner, the death benefit payable to the spouse is included in the insured's probate estate. D)As beneficiary, Clarice can borrow against the death benefit during Raphael's life.

B)At Raphael's death, the variable life insurance policy death benefit will be paid to Clarice. Rationale As listed beneficiary, Clarice will receive the death benefit of the life insurance policy at Raphael's death. Option a is incorrect because only the owner of a life insurance policy is required to include the value in her federal gross estate. In this question, Clarice is only the beneficiary; she does not have any right to the life insurance policy until Raphael's death. Option c is incorrect. A life insurance policy is included in the insured's probate estate only when the death benefit is payable to the insured or no designated beneficiary has been selected. Option d is incorrect because the beneficiary of a life insurance policy cannot borrow against the death benefit. C)

Jack owned a life insurance policy with his brother, Daniel, as the insured. When Jack died, his will specifically bequeathed the policy to his sister, Ginger. Which of the following statements regarding the value of the life insurance policy to include in Jack's federal gross estate is not true? A)If the life insurance policy is a term life insurance policy, the value is the unused premium. B)Because Daniel is still alive, the value of the policy included in the gross estate is zero. C)If the life insurance policy is a whole life policy in pay status, the value is equal to the unearned premium plus the interpolated terminal reserve. D)If the life insurance policy is a paid-up or single premium life insurance policy, its value is its replacement cost.

B)Because Daniel is still alive, the value of the policy included in the gross estate is zero. Rationale This statement is completely false. There is no such exception. The policy, like all other assets owned by the decedent, will be included in the gross estate, (with very few exceptions). All of the other statements are true.

Which of the following is not a valid settlement option for the designated beneficiary of a life insurance policy? A)A lump-sum payment of the death benefit. B)Individual Retirement Account Rollover. C)Life Annuity. D)Term Annuity.

B)Individual Retirement Account Rollover. Rationale A beneficiary of a life insurance policy cannot rollover the death benefit into an IRA. The designated beneficiary of a life insurance policy can choose to receive the death benefit as a lump sum payment, as an annuity (term or life), or the beneficiary can leave the death benefit on deposit with the insurer. In some situations, the owner of the life insurance policy will establish an irrevocable settlement option, thereby choosing the beneficiary's settlement option.

Laverne is the owner and insured on a $1,000,000 face value life insurance policy in pay status. Laverne's adjusted basis in the life insurance contract is $250,000. If Laverne gifts this life insurance policy to her daughter and listed beneficiary, Shirley, which of the following statements is correct? A)After the date of the gift, any dividends paid on the life insurance policy will be taxable to Laverne. B)Shirley can amend the beneficiary designation of the life insurance policy to include her son, Lenny, as a co-beneficiary. C)If Shirley dies before Laverne, Shirley's probate estate will include the replacement value of the life insurance policy. D)If Laverne dies within three years of the gift of the life insurance policy to Shirley, the death benefit will be included in Laverne's probate estate.

B)Shirley can amend the beneficiary designation of the life insurance policy to include her son, Lenny, as a co-beneficiary. Rationale After Laverne has gifted the life insurance policy to Shirley, Shirley can select the designated beneficiary of the life policy. Shirley has the right to change the beneficiary selected by Laverne and does not need Laverne 's approval to amend the designation. Option a is incorrect because any dividends issued on the life insurance policy will be paid to Shirley and the dividends are nontaxable distributions equal to return of capital. Option c is incorrect because the value of a life insurance policy in pay status is the sum of the interpolated terminal reserve plus any unearned premium. Option d is incorrect as the life insurance policy will be included in Laverne 's federal gross estate (not the probate estate) if she dies within three years of the gift of the life insurance policy.

The owner of a whole life insurance policy would like to exchange his life insurance policy for an annuity on his life. Currently, the value of the life insurance policy is $150,000, excluding a $50,000 loan the owner has against the life insurance policy, and the owner's adjusted basis in the policy is $65,000. Which of the following statements is true? A)If the owner exchanges the life insurance policy for an annuity, the owner must recognize a $135,000 capital gain on the exchange. B)The owner's basis in the annuity after the exchange will be $115,000. C)The exchange will be considered a transfer for valuable consideration. D)Each annuity payment that the owner receives from the annuity will be treated first as a tax free return of basis, then as taxable earnings once the basis has been fully recovered.

B)The owner's basis in the annuity after the exchange will be $115,000. Rationale In an exchange of a life insurance policy for an annuity, the owner of the life insurance policy must recognize gain to the extent he receives boot in the exchange. Outstanding loans against the life insurance policy are considered boot. In this problem, the owner has potential gain of $135,000 ($150,000 + $50,000 - $65,000), and must recognize gain to the extent he had a loan outstanding, or $50,000. Normally, the owner's adjusted basis in the life insurance policy will be carried over to the annuity, but if the owner recognizes any gain on the exchange or pays additional expenses, he will increase his adjusted basis in the annuity by the gain recognized or the expenses paid. Because the owner had to recognize gain on the loan, he will increase his adjusted basis by this recognized gain of $50,000. After the exchange, the owner's adjusted basis in the annuity is $115,000, the adjusted basis in the life insurance policy increased by the amount of gain recognized on the transaction ($65,000 + $50,000). Option c is incorrect as an exchange is not considered a transfer for valuable consideration. Option d is incorrect because each payment received from the annuity will be partially a return of basis and partially taxable interest income.

Last year, Omar gave a life insurance policy with a $400,000 death benefit to his son, Scout. At the time of the gift, the value of the life insurance policy was $50,000 and Omar had to pay $5,000 in federal gift tax. Omar unexpectedly died this year. What amount will be included in Omar's federal gross estate related to this life insurance policy? A)$5,000. B)$400,000. C)$405,000. D)$455,000.

C)$405,000. Rationale Life insurance proceeds on policies gratuitously transferred within three years of death are included in the gross estate of the donor. Gift tax paid within three years of death is included in the federal gross estate as well under the gross-up rule.

In an attempt to exclude the death benefit of a paid up $500,000 face value whole life insurance policy from his gross estate, Drake gifted the policy to his daughter. Six months prior to the gift, Drake had been diagnosed with a terminal illness and given a 12 month life expectancy by his doctor. What is the gift tax value of the gift of this policy? A)The replacement cost of the life insurance policy. B)The life insurance policy's interpolated terminal reserve plus any unearned premium. C)$500,000 discounted for Drake's six month life expectancy. D)The cash surrender value of the life insurance policy.

C)$500,000 discounted for Drake's six month life expectancy. Rationale If a physician has determined that the insured has a physical condition that is terminal, the value of a life insurance policy for gift tax purposes will be the death benefit, discounted for the predicted life expectancy of the insured.

Travis, 28, and his wife, 26, have recently moved into a new home. They financed $350,000 of the $500,000 purchase price and utilized all of their savings to pay the down payment of $150,000. Travis's wife stays at home with their 3-year old son, Alex, and is expecting a baby in two months. Which of the following statements is not correct? A)Travis should consider a 30 year term life insurance policy on his life which could fund his children's educational needs if he should die during the term. B)A universal life insurance policy would provide Travis with the insurance protection of a term life insurance policy and would also provide him with a tax-deferred savings mechanism. C)A whole life insurance policy would provide Travis with the least expensive temporary life insurance needed to eliminate the mortgage at his death. D)Travis should consider a whole life insurance policy on his life which could fund his children's educational needs or pay off the mortgage if he dies while those needs exist, and which could also provide Travis with a source of funds if he lives through his retirement.

C)A whole life insurance policy would provide Travis with the least expensive temporary life insurance needed to eliminate the mortgage at his death. Rationale A whole life insurance policy is a permanent type of insurance - eliminating a mortgage is a temporary need. Also, whole life insurance at Travis' age would have the highest premium. All of the other statements are correct.

Lorianne selected her son as the beneficiary of a whole life insurance policy on her life. Which of the following statements concerning this beneficiary designation is incorrect? A)Lorianne could have chosen her son and her daughter as co-beneficiaries. B)If Lorianne lists her nephew as the contingent beneficiary of the whole life insurance policy, her nephew will collect the death benefit if her son dies before Lorianne. C)If Lorianne entered an irrevocable beneficiary designation, she is the complete owner of the life insurance policy and can amend the irrevocable beneficiary designation at anytime. D)At Lorianne's death, her son will receive the death benefit of the life insurance policy.

C)If Lorianne entered an irrevocable beneficiary designation, she is the complete owner of the life insurance policy and can amend the irrevocable beneficiary designation at anytime. Rationale If Lorianne had entered an irrevocable beneficiary designation, she continues to be the owner of the life insurance policy, but she will need her son's permission to amend the beneficiary designation. All of the other statements are true.

Louie gave a $1,000,000 life insurance policy on his own life to his brother. At the date of the gift, the life insurance policy was valued at $200,000. Which of the following statements regarding the gift of this life insurance policy is correct? A)If Louie dies two years after this gift, his federal gross estate will include $200,000. B)If Louie dies four years after this gift, his federal gross estate will include $200,000. C)If Louie dies two years after this gift, his federal gross estate will include $1,000,000. D)If Louie dies four years after this gift, his federal gross estate will include $1,000,000.

C)If Louie dies two years after this gift, his federal gross estate will include $1,000,000. Rationale The three-year rule (IRC Section 2035) states that if an individual gratuitously transfers ownership of a life insurance policy on his life, or any incident of ownership in a policy on his life within three years of death, the death benefit of the policy is included in his federal gross estate. In this case, only answer c provides the correct solution. If Louie dies two years after the gift, the gratuitous transfer of the policy falls within the three-year rule and the death benefit is included in Louie's federal gross estate. All of the other options are incorrect.

Jerry is the owner, the insured, and the beneficiary of a whole life insurance policy. Which of the following situations regarding this scenario is incorrect? A)When Jerry dies, his federal gross estate will include the death benefit of the life insurance policy. B)When Jerry dies, his probate estate will include the death benefit of the life insurance policy. C)Jerry's estate will include the death benefit in its taxable income. D)If Jerry designates a new beneficiary before he dies, and the beneficiary is alive at the time of Jerry's death, the death benefit will be excluded from his probate estate.

C)Jerry's estate will include the death benefit in its taxable income. Rationale The IRC (Section 101(a)) provides an income tax exemption for a death benefit paid from a life insurance contract by reason of the death of the insured. In this case, Jerry's estate will receive the death benefit, but it will still be excluded from the taxable income of the estate because of the exemption provided by the IRC (Section 101(a)). All of the other statements are correct.

Which of the following is not a reason for using life insurance in an estate plan? A)The proceeds of the life insurance policy can be used to create liquidity for the decedent's estate. B)The proceeds of the life insurance policy can be used to eliminate any debt for the decedent's surviving spouse. C)The insured can borrow the death benefit from the life insurance policy to fund his retirement. D)Expected future education expenses can be funded with the death benefit of the life insurance policy.

C)The insured can borrow the death benefit from the life insurance policy to fund his retirement. Rationale The insured can borrow against the cash surrender value of the life insurance policy to fund his retirement. The insured cannot borrow the death benefit of the life insurance policy. All other statements are reasons for using life insurance in an estate plan.

In 2006, Donna, age 30, purchased a regular whole life insurance policy on her life and designated her sister, Robin, as the beneficiary. The policy death benefit is $1,000,000. On January 1, 2020, Donna, on the advice of her CFP® professional, assigned the policy to an ILIT. At the time, the cash value of the policy was $100,000. The named beneficiary of the trust is Robin and the trustee is James. Which of the following statements regarding the life insurance policy is/are correct? A)The gift, which was taxable, is $85,000, after the standard 15 percent discount. B)The taxable gift is $100,000. C)The value of the policy for gift tax purposes is the interpolated reserve plus the unexpired premium. D)The value of the policy for gift tax purposes is replacement value.

C)The value of the policy for gift tax purposes is the interpolated reserve plus the unexpired premium. Rationale This is an in-pay status whole life policy. Premiums are paid to age 100.

The owner of a life insurance policy has decided to surrender the life insurance policy to the insurer. Since inception of the life insurance contract, the owner has paid premiums of $100,000 and received cash policy dividends equal to $20,000. If at the surrender date, the owner receives a cash payment of $140,000 from the insurer, what is his gain/ loss subject to income tax on the life insurance policy? A)$0. B)$20,000. C)$40,000. D)$60,000.

D)$60,000. Rationale The owners adjusted basis in the property would be $80,000 - the sum of the premiums paid on the policy less any dividends received (a dividend on a life insurance policy is a return of the policy owner's adjusted basis). If the insurer pays a cash surrender value of $140,000, the gain on the policy would be $60,000 ($140,000-$80,000).

Watson, LLP. has four equal partners. All four partners are interested in entering into a buy-sell arrangement. How many life insurance policies would be purchased to properly fund a cross-purchase agreement? A)4 policies. B)6 policies. C)8 policies. D)12 policies.

D)12 policies. Rationale Each owner would need to purchase a life insurance policy on each of the other owners. Therefore, 12 policies would be purchased in total or 4(4-1) = 12.

Colleen transferred ownership of a whole life insurance policy on her life to an Irrevocable Life Insurance Trust (ILIT) six years ago and retained the right to borrow against the policy. When Colleen dies, the proceeds of the life insurance policy are: A)Included in Colleen's federal gross estate if she has any outstanding loans against the life insurance policy. B)Included in Colleen's federal gross estate if Colleen continued paying the policy premiums after the life insurance policy was transferred to the ILIT. C)Never included in Colleen's federal gross estate. D)Always included in Colleen's federal gross estate.

D)Always included in Colleen's federal gross estate. Rationale The IRC (Section 2042) states that if a decedent owns a life insurance policy on her own life or possesses any incidents of ownership in the policy on the date of her death, the policy death benefit will be included in her gross estate. The right to borrow against the life insurance policy is considered an incident of ownership which would cause inclusion in Colleen's federal gross estate. Because Colleen retained this right, her federal gross estate would include the death benefit of the whole life insurance policy owned by the ILIT. Option a is incorrect because as long as the decedent has the right to take a loan against the policy, it is considered an incident of ownership. There is no requirement that a loan be outstanding. Option b is incorrect because paying the premium on a policy transferred to an ILIT does not create the incidents of ownership that would cause inclusion in Colleen's federal gross estate.

ack purchased a life insurance policy on his own life and never designated a beneficiary. In this case, the life insurance policy death benefit is: A)Included in Jack's federal gross estate if Jack dies within three years of the initial premium payment. B)Included in Jack's federal gross estate if Jack paid the premiums until his death. C)Never included in Jack's federal gross estate. D)Always included in Jack's federal gross estate.

D)Always included in Jack's federal gross estate. Rationale Because Jack did not list a beneficiary, the death benefit is payable to Jack's estate and will be distributed per Jack's will or the intestacy laws of Jack's state of residency. There is no three-year rule with regard to the initial premium payment of the life insurance policy as listed in option a.

In which of the following situations would the death benefit of a life insurance policy be taxable, partially or wholly? A)Sissy, as designated beneficiary, received the $80,000 death benefit of Bud's life insurance policy. Bud had purchased the policy for $35,000 from his employer when he retired in 1997. B)Gilley's, Inc., received the $100,000 death benefit of Mickey's life insurance policy. In 1990, Mickey, the owner of 50% of the stock of Gilley's, Inc. sold the policy to Gilley's for $12,000 as part of an entity-type buy-sell agreement. C)Weakam, Ullo, and Evans, LLP, received the $1,000,000 death benefit of a life insurance policy on Randy Evans, one of the managing partners. Randy had sold the policy to Weakam, Ullo, and Evans, LLP in 1945 when the business was just starting out as part of an entity-type buy-sell agreement. D)Harley sold a $100,000 death benefit life insurance policy to Dusty for $35,000 as part of cross-purchase buy-sell agreement.Harley and Dusty were the only two shareholders of Cupper Corporation and each owned a policy on the other.

D)Harley sold a $100,000 death benefit life insurance policy to Dusty for $35,000 as part of cross-purchase buy-sell agreement.Harley and Dusty were the only two shareholders of Cupper Corporation and each owned a policy on the other. Rationale If a life insurance policy is transferred for valuable consideration, the death benefit in excess of the transferee's adjusted basis will be subject to income tax. An exception exists for any transfer of the life insurance policy for valuable consideration to the insured, a partner of the insured, a partnership in which the insured is a partner, a corporation in which the insured is a shareholder or officer, or a transferee who takes the transferor's basis in the contract. Option a is an example of a transfer to the insured. Option b is an example of a transfer to a corporation in which the insured is a shareholder. Option c is an example of a transfer to a partnership in which the insured is a partner. Option d does not fit any of the exceptions. The life insurance policy is transferred to Dusty, not Cupper Corporation.

Warren purchased a single premium life insurance policy on his life 15 years ago for $65,000. The current value of the policy is $155,000. Which of the following statements regarding Warren's life insurance policy is true? A)If Warren takes a loan of $140,000 against the cash surrender value of the life insurance policy, he will have long-term capital gain of $65,000. B)If Warren takes a loan of $65,000 against the cash surrender value of the life insurance policy, he will not have any taxable gain. C)If Warren takes a loan of $75,000 against the cash surrender value of the life insurance policy, he will recognize $10,000 of long-term capital gain. D)If Warren takes a loan of $155,000 against the cash surrender value of the life insurance policy, he will recognize $90,000 of taxable gain.

D)If Warren takes a loan of $155,000 against the cash surrender value of the life insurance policy, he will recognize $90,000 of taxable gain. Rationale Because Warren's life insurance policy was funded with a single premium payment, the policy is considered a modified endowment contract (MEC). Any loan from a MEC is considered taxable gain, taxed as ordinary income, to the extent there is any gain in the contract. Therefore, option d is correct because Warren takes a $155,000 loan from the contract and has $90,000 ($155,000-$65,000) of gain. Warren must recognize taxable gain as ordinary income to the extent of the gain inherent in the policy before receiving a return of capital. In answer a, if Warren borrowed $140,000, he would also recognize $90,000 of taxable gain, taxed as ordinary income. In option b, Warren would recognize $65,000 of taxable gain, taxed as ordinary income, if he took a loan of $65,000. If Warren borrowed $75,000 as in option c, Warren would have a $75,000 taxable gain, taxed as ordinary income.

Which of the following statements is true? A)Life insurance policy dividends are taxable as dividend income. B)Life insurance policy dividends kept on deposit with the insurer will generate tax-deferred interest income. C)If a life insurance policy lapses, any outstanding loans will be required to be repaid to the insurer immediately at the lapse. D)If a life insurance policy owner takes a loan from the policy, the death benefit of the policy will be reduced by any outstanding loans plus the accumulated interest due on the loan at the death of the insured.

D)If a life insurance policy owner takes a loan from the policy, the death benefit of the policy will be reduced by any outstanding loans plus the accumulated interest due on the loan at the death of the insured. Rationale Option d is a correct statement. Option a is incorrect as policy dividends are return of the policy owner's adjusted basis. Option b is incorrect as life insurance policy dividends kept on deposit with the insurer will generate taxable interest income to the life insurance policy owner. Option c is incorrect because the outstanding loan would be off set by the surrender value.

At age 69, Andre, a widower, needs more than his pension and Social Security income to pay his living and medical expenses. His children do not have the resources to help him and he has already liquidated his individual retirement accounts. Which of the following is true if Andre decides to surrender his whole life insurance policy to the insurer? A)Andre would receive the present value (using the actuarial factors according to Andre's life expectancy) of the life insurance policy death benefit. B)Any amount of surrender value paid to Andre would reduce the death benefit payable to the listed beneficiary of the policy dollar-for-dollar. C)To surrender the life insurance policy, Andre must receive the approval of the listed beneficiary of the life insurance policy. D)The surrender value of the policy would be paid to Andre and the life insurance contract would be canceled.

D)The surrender value of the policy would be paid to Andre and the life insurance contract would be canceled. Rationale If Andre surrenders the life insurance policy to the insured, the insurer will pay Andre the surrender value, the contract will be canceled, and correspondingly there will not be a death benefit payment at Andre's death. Option a is incorrect because if Andre surrender the life insurance policy, the surrender value is equal to the cash accumulation account less a surrender charge from the insurer. Option b is incorrect because once the policy is surrendered the contract is canceled and no death benefit would be paid to the beneficiary. Option c is incorrect because Andre would not have to receive the approval of the listed beneficiary unless it was stated that he had made an irrevocable beneficiary designation.