Intuit Academy Tax Practice Exam

What is the tax treatment of life insurance proceeds received by a taxpayer?

1. They are included in gross income

2. They are tax-exempt and excluded from gross income

3. They can be partially taxed depending on the state

4. They are subject to capital gains tax

The correct answer is: They are tax-exempt and excluded from gross income

Life insurance proceeds received by a taxpayer are generally tax-exempt and excluded from gross income. This means that when a beneficiary receives a death benefit from a life insurance policy, they do not have to report that amount as income on their federal tax return, nor do they have to pay any taxes on it. This tax treatment is designed to provide financial relief to beneficiaries during what is often a difficult time, ensuring that they can utilize the full amount of the insurance benefit for their needs without the burden of additional taxation. While there might be certain exceptions (for example, if the policy was sold for a profit or if interest on the proceeds is earned), the overarching rule is that the face value of life insurance benefits received due to the insured's death is not subject to income tax.