Life insurance payouts are not treated as taxable income. However, a tax is imposed on the transfer of the “taxable estate” of a deceased person. This can also include payment of life insurance benefits to beneficiaries.
American journalist and author Mignon McLaughlin said it best, “Philosophy teaches a man that he can’t take it with him; taxes teach him he can’t leave it behind either.”
However, there is some comfort in the knowledge that life insurance payouts are not treated as taxable income.
Typically, a beneficiary does not pay income tax on a gift or inherited property. However, if a beneficiary later decides to sell the inherited property later on, he or she can be taxed in the form of capital gains or losses.
To calculate the amount of tax liability, the beneficiary needs to know the gift or inherited property’s price. Inherited or gifted property has a different tax structure. It is based on whether the property was received as a gift during life or simply inherited.
One way to remove insurance from a taxable estate is to relinquish all rights to it by assigning the policy to someone else. However, there could still be a gift tax imposed on it. But only the cash value of the policy and the unearned and subsequent premiums paid by you are subject to the tax, and not the face value of the policy.
“This is very rare,” said Keith Diffenderffer, President of Endowment Income, LLC in Chula Vista, Calif. “It would probably require a contractual irrevocable beneficiary designation to be enforceable.”