HS 321 Module 11

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HS 321 Module 11
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HS 321 Module 11
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  1. Death benefits received under an annuity contract are tax free in the same manner as life insurance proceeds.

    a) True
    b) False  
    b) False 

    Death benefits payable under an annuity contract do not qualify for the exclusion applicable to life insurance proceeds. 
  2. Life insurance death benefits are generally excluded from the gross income of an individual beneficiary but are taxable income to a trust.

    a) True
    b) False  
    b) False 

    Lump-sum proceeds payable by reason of the insured's death are generally excluded from the gross income of individuals, trusts, and estates. 
  3. A surviving spouse may exclude from income up to $1,000 of interest payable under any settlement option.

    a) True
    b) False  
    b) False 

    If the amount is received with respect to a death occurring on or before October 22, 1986, a surviving spouse is entitled to the $1,000 income exclusion for payments received under all options except the interest-only option. With respect to insureds whose death occurred after October 22, 1986, the $1,000 interest exclusion was repealed. 
  4. Accelerated death benefits paid under a life insurance contract to a terminally ill insured are generally excludible from gross income as amounts paid by reason of death.

    a) True
    b) False  
    a) True 
  5. Certain withdrawals from universal life policies that result in a reduction in the death benefit may be taxed on a last-in, first-out (LIFO) basis.

    a) True
    b) False  
    a) True 
  6. When a life insurance policy is surrendered during the period that the contract is in force, the owner will be subject to income taxation on the amount received in excess of his or her cost basis.

    a) True
    b) False  
    a) True 
  7. The portion of each installment of life insurance living benefits received income tax free under an installment option is found by dividing the investment in the contract by the expected total return.

    a) True
    b) False  
    a) True 
  8. A policyowner who surrenders a level-premium whole life insurance policy and elects one of the installment options will be taxed under the annuity rules.

    a) True
    b) False  
    a) True 
  9. When the primary beneficiary dies before receiving all installments under a fixed-period or fixed-amount option, the contingent beneficiary will be taxed on installment payments based on his or her life expectancy.

    a) True
    b) False  
    b) False 

    The contingent beneficiary will be taxed in the same manner as the primary beneficiary. The contingent beneficiary may exclude the same portion of each installment from his or her gross income as the primary beneficiary was entitled to exclude. 
  10. Premium payments for life insurance generally constitute personal nondeductible expenses.

    a) True
    b) False  
    a) True 
  11. The transfer-for-value rule provides that if an insured transfers a policy on his or her life to another for valuable consideration, the transferee will receive the death proceeds free of income tax.

    a) True
    b) False  
    b) False 

    The transfer-for-value rule applies to the transfer of a life insurance policy for valuable consideration. When the insured dies, the transferee will have taxable income on that portion of death proceeds in excess of the amount of consideration paid on the transfer, plus the total net premiums subsequently paid by the transferee. 
  12. One exception to the transfer-for-value rule is a transfer from the insured to another shareholder of a corporation in which the insured is a shareholder or officer.

    a) True
    b) False  
    b) False 

    A transfer to another shareholder is not an exception to the transfer-for-value rule. 
  13. If the transfer of a life insurance policy falls within one of the enumerated exceptions to the transfer-for-value rule, the entire death proceeds will be received income tax free by the beneficiary.

    a) True
    b) False  
    a) True 
  14. Local law generally requires an insurable interest only at the time a life insurance policy is originally purchased.

    a) True
    b) False  
    a) True
  15. An individual who transfers a policy on his or her life to a qualified charity and continues to pay the premiums may deduct the amount of the premium payments each year as a charitable contribution only if the charity is the owner of the policy and has exclusive rights as owner.

    a) True
    b) False  
    a) True 
  16. An individual who transfers a policy on his or her life to a qualified charity and continues to pay the premiums may deduct the amount of the premium payments each year as a charitable contribution only if the charity is the owner of the policy and has exclusive rights as owner.

    a) True
    b) False  
    a) True 
  17. Under a split-dollar life insurance plan, the covered employee receives the full value of the insurance coverage income tax free.

    a) True
    b) False  
    b) False 

    The covered employee must generally include in gross income each year the value of the "economic benefit" received as determined by IRS guidance on this subject. 
  18. A corporation may take a deduction for premium payments made for insurance on the life of an officer of the corporation if the beneficiary is the corporation.

    a) True
    b) False  
    b) False 

    IRC Sec. 264 prohibits a deduction by any taxpayer for premiums paid on life insurance contracts if the taxpayer is directly or indirectly a beneficiary. 
  19. Interest on a life insurance policy loan of $50,000 may be deductible if the insured is a "key person" with respect to the taxpayer.

    a) True
    b) False  
    a) True 
  20. Allowable interest deductions for loans from business-owned policies are now subject to limitations based upon the "Moody’s" rate.

    a) True
    b) False
    a) True
  21. Interest deductions for loans from business-owned single-premium life insurance policies are limited to $1,000 annually.

    a) True
    b) False
    b) False 

    Interest on loans from single-premium life insurance policies cannot be deducted.
  22. Sally Snow is the beneficiary of her husband's $120,000 life insurance policy. Sally's husband died in September 2000. She elected to receive $7,800 annually under a life income option. Her life expectancy was 20 years when the life income option was chosen. How much of each annual annuity payment is included in her gross income?

    A) $1,800
    B) $6,000
    C) $7,800
    D) $3,800
    A) $1,800

    Under the settlement option chosen, Sally receives $7,800 annually; $6,000 represents the death benefit that is nontaxable to her. The remaining portion, $1,800, represents payment of interest, which is taxable as ordinary income.
    (this multiple choice question has been scrambled)
  23. A woman purchased a $100,000 whole life insurance policy on her life and designated her husband as beneficiary. Several years later the woman surrendered the policy for its cash value of $50,000. At the time of surrender, the woman had paid gross premiums of $45,000 and had received policy dividends of $10,000. What were the income tax consequences to the woman upon receipt of the cash surrender value?

    A) She received the entire $50,000 tax free.
    B) She received $45,000 tax free and $5,000 as ordinary income.
    C) She received $35,000 tax free and $15,000 as ordinary income.
    D) She received $15,000 tax free and $35,000 as ordinary income.
    C) She received $35,000 tax free and $15,000 as ordinary income.

    The woman's basis in the policy is $35,000 ($45,000 premiums ? $10,000 dividends received). Therefore the taxable amount is $15,000 ($50,000 received - $35,000 basis).
    (this multiple choice question has been scrambled)
  24. A corporation purchased a $50,000 whole life insurance policy on a man who was a key employee. Several years later the man terminated employment and his wife purchased the policy from the corporation with her own funds for $10,000. The wife designated herself as beneficiary and started paying the premiums. If the man were to die after his wife had paid net premiums amounting to $5,000, what would be the income tax consequences to the wife upon receipt of the policy death proceeds?

    A) income.
    B) She would receive $10,000 tax free and $40,000 as ordinary income.
    C) She would receive the entire $50,000 tax free.
    D) She would receive $15,000 tax free and $35,000 as ordinary income.
    D) She would receive $15,000 tax free and $35,000 as ordinary income.

    This is a transfer-for-value situation. The wife paid $10,000 for the policy and $5,000 in subsequent premiums, a total basis of $15,000. She must pay tax on the proceeds in excess of $15,000.
    (this multiple choice question has been scrambled)
  25. Under which of the following circumstances will a corporation's payment of premiums on a life insurance policy be taxable to an insured employee?

    I. The corporation purchases group term life insurance of $10,000 payable to the insured employee's personal beneficiary under a nondiscriminatory plan.

    II. The insured employee is the owner of an individual policy and the proceeds are payable to the employee's personal beneficiary.

    A) I only
    B) II only
    C) Both I and II
    D) Neither I nor II
    B) II only

    The insured employee is taxed on the coverage because the employee is the owner of the policy.I is incorrect because the insurance premiums would not be taxable. These premiums will qualify for the exclusion under IRC Sec. 79
    (this multiple choice question has been scrambled)
  26. A corporation pays the premiums on a life insurance policy on the life of its president. In which of the following situations may the corporation deduct the premiums as an expense?

    I. The corporation is the absolute owner and beneficiary of the policy.

    II. The president is the absolute owner of all rights under the policy and the corporation makes the premium payments pursuant to the president's compensation package.

    A) Both I and II
    B) I only
    C) II only
    D) Neither I nor II
    C) II only

    I is incorrect because a corporation cannot deduct premiums paid on a policy if the corporation is a beneficiary.
    (this multiple choice question has been scrambled)
  27. All the following transfers by sale of a life insurance policy are excluded from the transfer-for-value rules EXCEPT

    A) sale of the policy to a partner of the insured
    B) sale of the policy to a shareholder in a corporation in which the insured is also a shareholder
    C) sale of the policy to the insured
    D) sale of the policy to a corporation in which the insured is a shareholder
    B) sale of the policy to a shareholder in a corporation in which the insured is also a shareholder

    This sale of a policy to another shareholder is not an exception to the transfer-for-value rules.
    (this multiple choice question has been scrambled)
  28. All the following statements concerning the tax aspects of withdrawals from universal life policies are correct EXCEPT

    A) Special rules apply to withdrawals occurring during the first 15 policy years.
    B) Withdrawals will be taxable only if the policy is a modified endowment contract (MEC).
    C) Withdrawals associated with a reduction in the policy’s death benefit may be subject to "last-in, first-out" (LIFO) tax treatment.
    D) Withdrawals during the first 5 policy years may have a higher taxable portion than withdrawals made during years 6 through 15.
    B) Withdrawals will be taxable only if the policy is a modified endowment contract (MEC).

    Withdrawals from such policies may be taxable even if the policy is not a MEC.
    (this multiple choice question has been scrambled)
  29. The 10 percent penalty will apply to the total amount of any withdrawal from a MEC.

    a) True
    b) False  
    b) False 

    The 10 percent penalty will apply only to that portion of a withdrawal from a MEC that is subject to the federal income tax; that is, the portion attributable to the gain in the policy on a LIFO basis. In addition, the penalty tax is generally applicable to gains withdrawn from a MEC before the policyowner reaches age 59 1/2. Moreover, it does not apply to payments attributable to disability or annuitized payments. 
  30. A life policy death benefit increase linked directly to the consumer price index will not be treated as a material change under the MEC rules.

    a) True
    b) False  
    a) True 
  31. All MECs issued by the same insurer to a policyowner during any calendar year will be treated as one policy for purposes of the MEC tax rules.

    a) True
    b) False
    a) True
  32. All of the following statements are correct regarding the income tax treatment of death benefits EXCEPT:

    A) If the death benefit is paid in a lump sum to the decedent's estate, the death benefit will be income tax-free to the estate.
    B) If the death benefit is held by the insurer, any interest payments received by the beneficiary will be taxable as ordinary income.
    C) Death benefits paid under accident and health insurance contracts are excluded from the recipient's gross income.
    D) Death benefits paid under an annuity contract are excluded from the recipient's gross income.
    D) Death benefits paid under an annuity contract are excluded from the recipient's gross income.

    Generally, life insurance death benefits received by the beneficiary are excluded from the beneficiary's gross income. However, this exclusion does not apply to death benefits payable under an annuity contract.
    (this multiple choice question has been scrambled)
  33. Marybeth is the beneficiary of her husband's $180,000 life insurance policy. She elected to receive $10,500 annually under a 20-year fixed installment payment option. How much of each annual annuity payment is included in her gross income?

    A) $1,500.
    B) $500.
    C) $9,000.
    D) $7,500.
    A) $1,500.

    The $180,000 death benefit will be income tax-free to Marybeth. However, the death benefit must be
    pro-rated over the installment period of 20 years. Therefore, $9,000 ($180,000 / 20) of each payment will be income tax-free. Marybeth will pay income tax on $1,500 ($10,500 annual payment less $9,000
    tax-free) of each payment.
    (this multiple choice question has been scrambled)
  34. Which of the following statements is correct regarding the taxation of life insurance proceeds?

    A) A contingent beneficiary will always receive proceeds tax free after the death of a primary beneficiary.
    B) If a surviving spouse chooses the interest-only settlement option, up to $500 of interest income is tax-free each year.
    C) If the death benefit of a life insurance policy is paid to an irrevocable trust, the benefit will be taxable to the trust.
    D) Accelerated death benefits paid from a policy to a terminally ill insured are generally excluded from gross income.
    D) Accelerated death benefits paid from a policy to a terminally ill insured are generally excluded from gross income.

    If a primary beneficiary is receiving the proceeds under the installment method, and the primary beneficiary dies before receiving all installments, the contingent beneficiary will be taxed on any installments received in the same manner the primary beneficiary is taxed.

    The death benefit of a life insurance policy is income tax free to the beneficiary, even if the death benefit is paid to a trust.

    If the interest-only settlement option is selected, all interest income received by the spouse (or any other beneficiary) is taxed as ordinary income. There is no exclusion permitted.
    (this multiple choice question has been scrambled)
  35. Which of the following statements is/are correct regarding the income taxation of death benefits from a life insurance policy?

    I. For deaths occurring after 1995, a surviving spouse beneficiary may exclude up to $1,000 of interest if an installment option has been chosen.

    II. If a trust owns the life insurance policy, a lump sum death benefit paid from the policy to the trust will be taxable at trust income tax rates.

    A) Neither I nor II.
    B) Only II.
    C) Only I.
    D) Both I and II.
    A) Neither I nor II.

    I is incorrect. This rule is only applicable to deaths occurring before October 23, 1986.
    II is incorrect. Lump sum death benefits are generally income tax-free, even if held within a trust.
    (this multiple choice question has been scrambled)
  36. Ramon has been certified by a physician as having an illness that will result in death within 24 months. Since he needed cash, Damon sold his $700,000 life insurance policy to a viatical settlement provider for $300,000. Immediately before the sale, the policy had a cash value of $200,000, and
    Damon has paid $160,000 of premiums to date.

    What are the income tax ramifications of the sale of this policy?

    A) Damon will be taxed on the $100,000 gain if he survives more than 24 months.
    B) Damon will be taxed on the $140,000 gain regardless of when his death occurs.
    C) Damon will receive the $300,000 income tax-free.
    D) Damon will be taxed on the $40,000 gain regardless of when his death occurs.
    C) Damon will receive the $300,000 income tax-free.

    Since Damon is terminally ill (expected to die within 2 years), the amounts received will be excluded from his gross income, regardless of when his death actually occurs.
    (this multiple choice question has been scrambled)
  37. Which of the following statements is correct regarding amounts withdrawn from a life insurance policy before the death of the insured?

    A) If a policy permits withdrawals, the cash value buildup will be taxable each year to the policy owner under the doctrine of constructive receipt.
    B) If the policy is classified as a modified endowment contract, loans and withdrawals will generally be income tax-free.
    C) Policy dividends that are used to purchase additional insurance coverage will be taxable to the policy owner.
    D) If made during the first 15 policy years, withdrawals associated with a reduction in the policy's death benefit will subject to LIFO basis recovery.
    D) If made during the first 15 policy years, withdrawals associated with a reduction in the policy's death benefit will subject to LIFO basis recovery.

    Withdrawals from a life insurance policy are usually taxed FIFO basis recovery (basis first). However, in this situation, the withdrawal will be taxed LIFO basis recovery (earnings first).

    Generally, the doctrine of constructive receipt will not apply to life insurance cash values. Note: the policy must satisfy certain actuarial tests.

    Policy dividends generally represent a return of premium, and will not be taxable if paid out or used to purchase additional insurance.

    If the policy is a MEC, loans and withdrawals are subject to LIFO basis recovery, meaning the loan or withdrawal will be partially or fully taxable.
    (this multiple choice question has been scrambled)
  38. Which of the following statements is/are correct regarding lump sum payments of the cash value from a life insurance policy?

    I. If the cash value exceeds the policy owner's cost basis, the gain on the policy will be taxed at capital gain rates.

    II. If the policy owner's cost basis exceeds the cash value, the loss on the policy will be deductible as a miscellaneous itemized deduction.

    A) Neither I nor II.
    B) Both I and II.
    C) Only I.
    D) Only II.
    A) Neither I nor II.

    I is incorrect. If the cash value exceeds the policy owner's cost basis, the gain on the policy will be taxed at ordinary income tax rates.

    II is incorrect. If the policy owner's cost basis exceeds the cash value, the loss on the policy will be non deductible.
    (this multiple choice question has been scrambled)
  39. Which of the following statements is/are correct regarding the deductibility of life insurance premiums?

    I. An individual making an absolute assignment of a life insurance policy to charity will be entitled to deduct, as a charitable deduction, future premiums paid by the individual.

    II. An employer can deduct premiums paid on a policy owned by an employee that insures the employee's life.

    A) Neither I nor II.
    B) Only II.
    C) Both I and II.
    D) Only I.
    C) Both I and II.
    (this multiple choice question has been scrambled)
  40. Which of the following situations would premium payments be deductible by the payer for federal income tax purposes?

    A) A corporation pays premiums on a disability policy on one of its employees, and the benefits are paid directly to the employee in the case of disability.
    B) An individual pays premiums on a personal disability income insurance policy.
    C) An individual pays premiums on a universal life insurance policy covering the life of his spouse.
    D) A corporation pays premiums on a key person life insurance policy covering one of its executives.
    A) A corporation pays premiums on a disability policy on one of its employees, and the benefits are paid directly to the employee in the case of disability.

    Generally, premiums paid on business life insurance are not deductible.

    Premiums paid by an individual on a personal disability policy are non-deductible.

    Life insurance premiums paid by an individual are treated as personal expenses and are non-deductible.
    (this multiple choice question has been scrambled)
  41. Which of the following statements is/are correct regarding life insurance benefits received in the form of installment payments?

    I. When the policy owner receives the cash value under the installment option, the owner is taxed based on the annuity rules prescribed by the Internal Revenue Code.

    II. When a primary beneficiary dies before receiving all of his or her installment payments, the contingent beneficiary will receive the remaining payments income tax-free.

    A) Both I and II.
    B) Neither I nor II.
    C) Only I.
    D) Only II.
    C) Only I.

    II is incorrect. The contingent beneficiary will be taxed in the same manner as the primary beneficiary. A portion of the payments will be taxable, and a portion will be tax-free.
    (this multiple choice question has been scrambled)
  42. Which of the following sales of a life insurance policy would be considered a transfer-for-value?

    A) Sale by the owner-insured to a corporation in which the insured is an officer.
    B) Sale by the owner-insured to a shareholder of a corporation in which the insured is also a shareholder.
    C) Sale by the owner-insured to a partnership in which the insured is a partner.
    D) Sale of a corporate-owned life insurance policy to the insured.
    B) Sale by the owner-insured to a shareholder of a corporation in which the insured is also a shareholder.

    A sale to another shareholder is a transfer-for-value.
    (this multiple choice question has been scrambled)
  43. All of the following transfers would violate the transfer-for-value rule, causing the death benefit of a life insurance policy to be taxable, EXCEPT:

    A) David, a non-owner employee of ABC Company, sells his personal life insurance policy to ABC Company.
    B) Margaret, whose husband died three years ago, sells her personal insurance policy to her son, to get the proceeds out of her estate.
    C) Ron, a partner in Pride Partnership, sells his existing life insurance policy to Jan, another partner in Pride.
    D) Stan, a shareholder XYZ Corporation, sells his existing life insurance policy to Mary, another shareholder of the corporation.
    C) Ron, a partner in Pride Partnership, sells his existing life insurance policy to Jan, another partner in Pride.

    The sale of a policy to a partner of the insured is not subject to the transfer-for-value rule.
    (this multiple choice question has been scrambled)
  44. Which of the following transfers of life insurance would be considered a transfer-for-value for
    income tax purposes?

    A) John transfers his $200,000 variable universal life insurance policy to his former spouse Mary pursuant to their divorce agreement.
    B) ABC Corporation transfers a $1,000,000 key person life insurance policy on one of its executives to XYZ Corporation pursuant to a tax-free reorganization.
    C) Mary, the owner of a $300,000 whole life policy on the life of her husband, sells the policy to her husband for $20,000.
    D) Alice and Bruce, each 50% owners of AB Corporation, transfer existing policies on their own lives to each other to fund a cross-purchase buy-sell agreement.
    D) Alice and Bruce, each 50% owners of AB Corporation, transfer existing policies on their own lives to each other to fund a cross-purchase buy-sell agreement.

    The transfer of existing insurance policies among shareholders of a corporation is considered a transfer for value. A transfer to a corporation, partnership, or partner would NOT be considered a transfer for value.

    Under the "carryover basis" exception of the transfer for value rule, transfers pursuant to a tax-free corporate reorganization are not considered a transfer for value.

    Under the "carryover basis" exception of the transfer for value rule, transfers pursuant to a divorce are not considered a transfer for value.

    Transfers to the insured are not considered a transfer for value.
    (this multiple choice question has been scrambled)
  45. Which of the following statements is correct regarding the concept of insurable interest?

    A) A business could possibly have an insurable interest on an individual who is not an employee of the business.
    B) The requirement of insurable interest must be satisfied at the time of the insured's death.
    C) Only close family members can have an insurable interest.
    D) The concept of insurable interest has no. application to the taxation of life insurance proceeds.
    A) A business could possibly have an insurable interest on an individual who is not an employee of the business.

    f insurable interest does not exist, life insurance is considered a taxable "wagering" contract.

    The insurable interest requirement must be met at the time of the policy inception.

    Business associates can also have an insurable interest.
    (this multiple choice question has been scrambled)
  46. David owns a permanent life insurance policy with a death benefit payable to his spouse. David's employer pays the premiums as part of David's compensation package.

    Which of the following statements is correct with respect to this arrangement?

    A) The premiums paid will be deductible by David's employer.
    B) The death benefit received by David's spouse would be subject to income tax.
    C) The tax treatment to David would change if the plan was discriminatory. 
    D) The premiums paid by the employer will not be taxed to David.
    A) The premiums paid will be deductible by David's employer.

    Since the premiums are deductible by the employer, they will be taxed to David, as though the employer paid him a salary.

    The tax treatment would be the same (employer receives deduction, employee is taxed) even if the plan is discriminatory.

    The death benefit would be income tax-free to the spouse.
    (this multiple choice question has been scrambled)
  47. Argyle Company established a non-equity endorsement split-dollar arrangement for employee Valerie. In the first year of the policy:

    • Premium paid by Valerie - $900
    • Premium paid by Argyle Company - $1,200
    • Table 2001 cost of insurance - $800

    What is the amount of Valerie's taxable income from the plan?

    A) $1,200.
    B) $800.
    C) $0.
    D) $300.
    C) $0.

    A non-equity endorsement split-dollar arrangement is taxed under the economic benefit regime. Therefore, the employee would include income equal to the Table 2001 cost of insurance, reduced by any amount paid by the employee.

    Since Valerie paid premiums of $900, and this cost exceeded the Table 2001 cost of insurance, she will not be required to include any amount in her taxable income relating to this split dollar arrangement.
    (this multiple choice question has been scrambled)
  48. All of the following statements are correct regarding income tax restrictions on amounts paid in
    connection with life insurance contracts EXCEPT:

    A) Section 264 prohibits a deduction for premiums paid on a life insurance policy if the taxpayer is a beneficiary.
    B) Interest on loans from a single-premium life insurance policy is not deductible. 
    C) Interest on a life insurance policy loan may be deductible if the insured is a key person and the loan does not exceed $150,000.
    D) The "Moody's rate" is used as the limitation on allowable interest deductions for loans from business-owned policies.
    C) Interest on a life insurance policy loan may be deductible if the insured is a key person and the loan does not exceed $150,000.

    Interest on a life insurance policy loan may be deductible if the insured is a key person and the loan does not exceed $50,000 (not $150,000).
    (this multiple choice question has been scrambled)
  49. Which of the following is/are considered a material change that could cause a life insurance policy to be considered a modified endowment contract (MEC)?

    I. The death benefit increases because it is linked directly to the consumer price index.
    II. The death benefit increases as a result of interest or earnings internal to the policy.

    A) Only II.
    B) Neither I nor II.
    C) Only I.
    D) Both I and II.
    B) Neither I nor II.

    I is incorrect. The increase in a death benefit linked directly to the CPI is not considered a material
    change under the MEC rules.

    II is incorrect. The increase in a death benefit as a result of interest or earnings internal to the policy is
    not considered a material change under the MEC rules.
    (this multiple choice question has been scrambled)
  50. ll of the following statements are correct regarding a modified endowment contract (MEC)
    EXCEPT:

    A) The death benefit will be partially taxable to the beneficiary if the beneficiary has not attained age 59 1/2
    B) If a policy that is classified as a MEC is exchanged for a new policy, the new policy is automatically considered a MEC.
    C) Loans and cash value withdrawals will be subject to a last-in, first-out (LIFO) basis recovery for tax purposes.
    D) A MEC is a life insurance policy that fails the seven-pay test.
    A) The death benefit will be partially taxable to the beneficiary if the beneficiary has not attained age 59 1/2

    The MEC rules apply to the taxation of loans or withdrawals from the cash value of the policy. The death benefit is income tax-free to the beneficiary.
    (this multiple choice question has been scrambled)
  51. 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?

    A) $O.
    B) $200,000. 
    C) $300,000.
    D) $400,000.
    B) $200,000. 

    $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%).
    (this multiple choice question has been scrambled)
  52. Which of the following situations can a "grandfathered" life insurance policy become a modified endowment contract?

    A) The policy is a survivorship policy and is kept in force, but the death benefit is reduced after the seventh policy year.
    B) The policy's death benefit increases as a result of purchase options exercised when the insured has a newborn infant.
    C) The death benefit of the policy increases as a result of a broad-based cost of living adjustment.
    D) The policy's death benefit increases due to interest or earnings within the policy.
    A) The policy is a survivorship policy and is kept in force, but the death benefit is reduced after the seventh policy year.

    If the policy is a survivorship policy and is kept in force, but the death benefit is reduced after the seventh policy year, the policy may become a MEC.
    (this multiple choice question has been scrambled)

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