Fred borrowed $7,500 from his friend, Jason and had some difficulty repaying the

Question

Fred borrowed $7,500 from his friend, Jason and had some difficulty repaying the loan as promised. Finally, Fred decided on a creative way to resolve the debt. He transferred a life insurance policy that he owned (on himself) to Jason. Face value on the policy was $125,000. At the time of the transfer the instrument had a cash surrender of $7,500. After the transfer Jason changed the beneficiary on the policy and named himself. Throughout the years, Jason continued to make payments (premiums). At the time of Fred’s death, Jason had made $12,500 in premium payments in total. Jason collected the face amount of $125,000 upon the death of his friend, Fred.

Question: What impact does this whole transaction have on Jason’s taxes, if any?

To answer this question, use the Internal Revenue Code. You may refer to a textbook but you may not base the answer on the textbook – you must reference the IRC section. What keywords did you use in your search to derive this answer?  

Explanation / Answer

Generally benefit received from life insurance is not taxable. It cannot be taken to the taxable income. However any interest received from insurance policy is taxable

However in this case Fred Transfer his insurance policy as repayment for his debt to the Jason. Therefore we need to consider Section 1035 exchange. According to that distribution of other property or the cancellation of a contract loan at the time of the exchange may be taxable and reportable on a separate form 1099-R. Therefore face amount of $125 000 life insurance is taxable and you can’t deduct premium payment as deductible.

Section 7702

Key word,

Category: Interest, Dividends, Other types of income

Sub-Category: Life insurance & Disability insurance proceeds

Related Questions

Navigate

• Browse (All)
• Browse F
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.