A taxpayer surrenders a life insurance policy for its cash value of $120,000. Total premiums paid were $80,000. The taxpayer had previously received $10,000 in tax-free dividends from the policy. What is the taxable amount recognized upon surrender?

Answer options:

$40,000

$120,000

$50,000

$30,000

How to approach this question

Calculate Adjusted Basis: Premiums Paid - Tax-Free Dividends Received. Gain = Cash Surrender Value - Adjusted Basis.

Full Answer

C.$50,000✓ Correct

IRC §72(e). Gain = Amount Received - Investment in Contract (Basis). Basis = Premiums Paid ($80,000) - Tax-Free Dividends ($10,000) = $70,000. Gain = $120,000 - $70,000 = $50,000 ordinary income.

Common mistakes

Forgetting to reduce basis by the dividends received.

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