Robyn owns a life insurance policy that has been classified as a modified endowment contract.
The policy has a cash value of $700,000 and a basis of $500,000. If she takes a $300,000 loan from the policy, what will be the taxable amount?
$200,000 will be taxable to Robyn. The basis in a MEC is recovered LIFO (last-in, first-out). Loans and cash withdrawals from a MEC are recovered earnings first. Robyn currently has $200,000 ($700,000 cash value less $500,000 basis) of earnings in the MEC. Therefore, the first $200,000 of her loan would be subject to income tax.
The earnings in this MEC are $200,000 ($600,000 cash value less $400,000 basis). Therefore, of the $300,000 loan, $200,000 will be taxable. The tax will be $60,000 ($200,000 x 30%).
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