Federal Income Tax on Life Insurance
What is the federal income tax on life insurance proceeds?
Most people wonder if they have to pay federal income tax on life insurance proceeds. The answer is that you do not have to pay federal income tax on life insurance proceeds that are paid to you because of the death of the insured person unless the policy was turned over to you for a price. In another word, most life insurance proceeds are partially taxable and you are likely to have to pay federal income tax on some parts of the life insurance proceeds.
When you receive lump sum life insurance proceeds
If death benefits are paid to you in a lump sum or other than at regular intervals, include in your income only the benefits that are more than the amount payable to you at the time of the insured person's death.
If the benefit payable at death is not specified, you include in your income the benefit payments that are more than the present value of the payments at the time of death.
When the life insurance proceeds are in installments
The IRS has different rules for the federal income taxation of life insurance proceeds that are received in installments. If you receive life insurance proceeds in installments, you can exclude part of each installment from your income.
To determine the excluded part, divide the amount held by the insurance company (generally the total lump sum payable at the death of the insured person) by the number of installments to be paid. Include anything over this excluded part in your income as interest.