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25 Cards in this Set
- Front
- Back
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Estate Taxes
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excise taxes levied on the right to transfer property of the deceased owner.
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Inheritance Taxes
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levied on the right of the heirs to receive
property of the deceased |
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Death Tax
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refers to both Estate and Inheritance taxes.
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Taxation of Personal Life Insurance:
Premiums |
1. For individuals, premiums are considered a personal expense and are not deductible.
2. When an employer pays the premium on an employee’s contract, the premium is tax-deductible as a business expense to the employer unless named as the beneficiary. 3. Employer paid premiums in connection with group life insurance shall not constitute taxable income to the employee unless the death benefit exceeds $50,000. All premiums for amounts above $50,000 are reported as taxable income. |
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Taxation of Personal Life Insurance:
Cash Values |
1. A cash value policy will experience increases in the cash value annually. These increases are not taxable at the time they are credited to the policy.
2. Upon the partial withdrawal of cash or the surrender of a policy, the owner is taxed on the contract equity. This is the Cost Recovery Rule. The cash value minus the sum of premiums paid equals equity. |
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Taxation of Personal Life Insurance:
Policy Loans |
1. The interest paid on a personal loan from a cash value policy is not tax-deductible.
2. The interest paid on a life insurance loan is considered personal, and has not been deductible since 1990. |
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Taxation of Personal Life Insurance:
Dividends |
1. The dividends themselves are not taxable since dividends are considered a return of unearned premium.
2. In general, the interest earned on dividends is taxable as ordinary income in the year earned. |
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Taxation of Personal Life Insurance:
Amounts received by the Beneficiary (Claims) |
1. As a general rule, the principal isn't considered taxable income, but any earned interest is taxable.
2. Lump sum death benefits are exempt of any income taxes. 3. When installment payments via settlement options include principal and interest, the interest is taxed as ordinary income in the year received. |
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Taxation of Personal Life Insurance:
Accelerated Death Benefits |
Generally the payment of an accelerated death benefit is not reported as taxable income to a recipient if the benefit payment is "qualified"
To be a qualified benefit the benefit must meet the following conditions: 1. A physician must give a prognosis of 24 months or less, life expectancy, for the named insured 2. The amount of the benefit must at least be equal to the present value of the reduced death benefit remaining after payment of the accelerated benefit. 3. The insurer provides a monthly report for the insured showing the amount paid and the amount of benefit remaining in the life insurance policy. The Accelerated Death Benefit is normally referred to as a rider. (Some state codes refer to this benefit as a provision while others call it an option.) It may be used for Terminal Illness, Chronic Disease, Nursing Home and Long-Term Care benefits. It is not a source of Disability Income benefits. It is an advance of the death benefit while the insured is still alive and is also known as a Living Benefit. |
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Values Included in Insured's Estate
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Life insurance proceeds are included as part of the insured’s taxable estate when:
1. The insured has any incidence of ownership at the time of death. 2. The proceeds are payable to the insured’s estate. 3. The transferred ownership or gifting occurred within three years of death. |
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Charitable Gifts of Life Insurance
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Advantages
1. The donor may remain anonymous if so desired 2. The size of the gift is determined by the death benefit 3. The entire amount is guaranteed even if the insured dies after only one premium payment 4. Very little documentation is necessary for the IRS Disadvantages 1. May be an insurable interest concern in some states 2. Death benefit might (in some cases) become part of a decedent's estate |
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Modified Endowment Contracts (MECs)
The Technical and Miscellaneous Revenue Act of 1988 (TAMRA) |
After June 20, 1988, all life insurance contracts issued which do not pass the 7-Pay Test are identified as Modified Endowment Contracts (MECs) and, therefore, lose many of their tax advantages.
Policies dated prior to June 20 are grandfathered and are not required to meet the 7-Pay Test. Once a contract is determined to be a MEC, it remains a MEC for the life of the contract. 1. The 7-Pay Test compares the premiums paid for the policy during the first seven years with seven annual net level premiums for a 7-Pay Policy; Single premium life is always a MEC. The IRS views the increase in the face amount as a material change, this requires a new 7-Pay Test. A policy issued prior to June 20, 1988 must pass the 7-Pay Test if the face amount is increased by a material change. Increases by a paid up additions dividend option or a cost of living rider are not considered as material changes. 2. If a contract is deemed to be a MEC, then any funds that are distributed are subject to a “last-in, first-out” tax treatment, rather than the normal “first-in, first-out” tax treatment. 3. Funds distributed are also subject to a 10% penalty on any taxable gains withdrawn before age 59 1/2 . This is considered a premature distribution. 4. Taxable distributions include partial withdrawals, cash value surrenders and policy loans (including automatic premium loans). |
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Excess distributions exempt from the 10% penalty
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1. Distributions made on or after the taxpayer reaches age 59 1/2 .
2. Distributions attributable to the death or total disability of the recipient. 3. Part of a series of equal periodic payments (at least annually) made for the life of the taxpayer or the joint lives of the taxpayer and his/her beneficiary by the use of settlement options. |
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Life Insurance Transfer for Value Rule
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A life insurance policy may be transferred to another person in exchange for a valuable consideration.
The tax-exempt status of the death proceeds are then lost unless the transfer is to a spouse or business partner presently engaged in business with the policyowner. The Internal Revenue code clearly states the death benefit will be taxed if the policy is transferred. The law prevents a firm from purchasing tax-exempt life proceeds and evading taxation. If the policy is gifted, the proceeds will remain tax-exempt unless the gifting policyowner acquired the policy by a transfer for value. |
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1035 Tax Free Exchange
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1. Internal Revenue Code 1035 provides that no gain or loss will be recognized on certain exchanges
of contracts relating to the same insured: a. When one life insurance policy is exchanged for another life insurance policy, an endowment or an annuity contract (Whole Life for a Universal Life). b. When one endowment is exchanged for another endowment that provides for payments on or before the original endowment date. An endowment may be exchanged for an annuity contract, but the IRC 1035 does not authorize the exchange of endowments for any life insurance policy. c. When exchanging annuity contracts within the same company the owner is attempting to achieve a better interest rate. Tax deferment continues throughout the transaction. 2. A 1035 exchange is actually the assignment by the original insurer to the replacing insurer. 3. This process allows for the assets of one annuity/insurance policy to be transferred to another and continue the tax-deferred status of the invested funds. |
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Taxation of Annuities:
Accumulation and Annuity Phases |
interest earned during the
accumulation period is not taxable until annuitization begins and the annuitant starts receiving benefits. Upon receipt of benefits, an annuitant is taxed on the amount of earned interest, not the principal. a. If an annuity is surrendered, any amount received over the cost basis must be reported and is taxed as ordinary income. b. When the annuitant begins receiving distribution payments of principal and interest, the taxation of these payments depend upon the type of annuity option selected for the distribution. |
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Taxation of Annuities:
Distributions at Death |
If the decedent's annuity payments cease upon death, nothing is included in the gross estate
a. If annuity payments are to continue to another person upon an annuitant's death, the survivor's proceeds are included in the gross estate. b. When a lump sum is paid, to a beneficiary during either phase of an annuity, that portion of benefit that exceeds the total contributions of the owner must be reported to the IRS as income. |
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Taxation of Annuities:
The Deceased's Estate |
the value of an annuity or other payments received under an individual retirement account (IRA) to the beneficiary are to be included in the decedent's gross estate.
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Nonqualified Deferred Compensation Plans
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1. A nonqualified deferred compensation plan is any employer provided retirement plan that does not comply with the ERISA requirements that apply to qualified plans.
2. Nonqualified deferred compensation plans are most commonly used when an employer wants to select certain key employees for which to provide a retirement plan. 3. The employer is not entitled to deduct contributions to the plan until the year in which a covered employee receives income from the plan. The employer’s cost basis is equal to premiums paid. 4. Earnings in the plan are tax deferred to the employee until he/she receives income from the plan. |
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Government Regulations: Funding Issues -
Defined Benefit Plan |
a qualified pension plan that guarantees a specified level benefit at retirement.
A defined benefit plan must pass a minimum participation test; the lesser of 50 employees or 40% of all the employees of that employer, wthis is referred to as the (50–40) test. |
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Government Regulations: Funding Issues -
Defined Contribution Plan |
any type of retirement plan that is based solely on the amount of
contributions made to the plan. The benefits are not determined until the date of retirement. |
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Government Regulations: Funding Issues - Tax Reform Act of 1986
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states no more than $200,000 of compensation shall be used to calculate either a Defined Benefit or Contribution Retirement Plan.
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Government Regulations:
Employee Retirement Income Security Act (ERISA) |
The Employee Retirement Income Security Act of 1974 (ERISA) provided provisions pertaining to
participating, vesting and funding which will influence every aspect of retirement plans. The legal and tax details are extremely complex and beyond the scope of this course, however, some of the key elements of a plan are listed: |
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Government Regulations:
Employee Retirement Income Security Act (ERISA) 1-5 |
1. Determine eligibility and apply the nondiscrimination requirements regarding age and sex.
2. Normal retirement age is essential in estimating costs. 3. Benefit formula is commonly 50% to 70% of the employees’ average compensation in the five to ten years immediately before retirement. 4. Maximum benefits are required in plans when benefits for key employees might be greater than for other employees. 5. Supplemental benefits are those such as death, disability and other authorized withdrawals of benefits during the pre-retirement period. |
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Government Regulations:
Employee Retirement Income Security Act (ERISA) 6-10 |
6. Employee contributions must be determined to be contributory or noncontributory.
7. Vesting allows the employee to be able to withdraw all contributions plus interest if he/she discontinues employment. The longer an employee stays with the company, the greater the percentage of funds “vested.” 8. Alienation of Benefits – the plan may not distribute, segregate, or otherwise attach any portion of participants’ benefits in favor of the participant’s spouse, or former spouse, unless it is mandated by a qualified domestic relations order. 9. The trustee of a retirement fund must ignore any claims of indebtedness received on behalf of an employee unless it is from the IRS in relation to delinquent taxes, then the claim must be honored. 10. A plan is considered Top Heavy when the accrued benefits of certain officers, owners, key employees and the beneficiaries exceeds 60% of the total accrued value of the plan. A Top Heavy plan must be adjusted to comply with IRS code. |
