Oregon Tax Consultants Practice Exam

Are life insurance proceeds considered taxable income to the beneficiary?

1. Yes, they are fully taxable

2. No, they are not taxable when received

3. Only the interest earned is taxable

4. Only if the policy was sold

The correct answer is: No, they are not taxable when received

Life insurance proceeds are generally not considered taxable income to the beneficiary when received. This means that if a beneficiary receives a payout from a life insurance policy following the death of the insured, that amount is typically exempt from federal income tax. The rationale behind this is rooted in the principle that life insurance is designed to provide financial support to the beneficiaries in the event of the insured's death, rather than serving as a source of income. However, it is important to note that any interest earned on the life insurance proceeds once they are received by the beneficiary is taxable, which aligns with tax rules on interest income. In cases where the policy is sold for more than its basis, there could also be different tax implications, but those situations are distinct from the general rule that life insurance payouts are not taxable. This understanding establishes a clear guideline on how life insurance proceeds are treated for tax purposes, ensuring that beneficiaries can rely on this financial support without it being diminished by tax liabilities.