CLU Income Taxation Principles 4 — Questions and Answers
Question 1: When an employer provides a split-dollar life insurance arrangement under the economic benefit regime, the employee must recognize income equal to:
- The full premium paid by the employer each year
- The economic benefit of the pure insurance protection provided (Correct answer)
- The increase in cash value attributable to employer contributions
- The entire death benefit times the employee's marginal tax rate
Correct answer: The economic benefit of the pure insurance protection provided
Under the economic benefit regime, the employee recognizes income equal to the cost of the current life insurance protection provided, measured by the Table 2001 rates.
Question 2: A corporation owns a life insurance policy on a key executive and is the beneficiary. At the executive's death, the death benefit received by the corporation is:
- Fully taxable as ordinary income
- Subject to the corporate alternative minimum tax only
- Generally income-tax-free under IRC Section 101(a) (Correct answer)
- Taxable to the extent it exceeds the policy's cash surrender value
Correct answer: Generally income-tax-free under IRC Section 101(a)
Corporations generally receive life insurance death proceeds income-tax-free under IRC Section 101(a), subject to COLI rules for post-2006 policies.
Question 3: Which of the following life insurance policy loans triggers immediate income tax?
- A loan from a non-MEC whole life policy still in force
- A loan from a MEC that constitutes a distribution (Correct answer)
- An automatic premium loan that prevents a lapse
- A policy loan on a term life policy with no cash value
Correct answer: A loan from a MEC that constitutes a distribution
Loans from a Modified Endowment Contract (MEC) are treated as distributions subject to LIFO taxation, making gains immediately taxable.
Question 4: For a self-employed individual, health insurance premiums paid for themselves, their spouse, and dependents are deductible:
- As an itemized deduction subject to the 7.5% AGI floor
- Above-the-line up to 100% of net self-employment income (Correct answer)
- Only if the individual has no access to an employer-subsidized plan
- As a business expense on Schedule C reducing self-employment tax
Correct answer: Above-the-line up to 100% of net self-employment income
Self-employed individuals may deduct 100% of health insurance premiums above the line, but not to exceed net self-employment income.
Question 5: Which statement correctly describes the income tax treatment of long-term care insurance benefits received?
- Benefits are always fully taxable as ordinary income
- Indemnity benefits are tax-free up to the per-diem limit; reimbursement benefits are tax-free for actual expenses (Correct answer)
- Benefits are taxable only if premiums were deducted as a business expense
- Benefits are subject to capital gains rates if the policy has been held more than one year
Correct answer: Indemnity benefits are tax-free up to the per-diem limit; reimbursement benefits are tax-free for actual expenses
Reimbursement-type LTC benefits are tax-free for actual qualified LTC expenses; indemnity-type benefits are tax-free up to the IRS per-diem dollar limit.
Question 6: A variable annuity owner age 55 takes a $20,000 withdrawal from a contract with a $15,000 cost basis and $30,000 of gain. Under LIFO rules, how much is subject to the 10% early withdrawal penalty?
- $0, because LIFO gain is exempt from the penalty
- $15,000
- $20,000 (Correct answer)
- $5,000
Correct answer: $20,000
Under LIFO, the entire $20,000 withdrawal comes from gain (since gain of $30,000 exceeds the withdrawal), and the full $20,000 is subject to both income tax and the 10% early withdrawal penalty.
Question 7: The income in respect of a decedent (IRD) rules apply to which of the following assets?
- Appreciated stock owned at death and sold by the estate
- Traditional IRA balances inherited by a non-spouse beneficiary (Correct answer)
- Life insurance death benefits received by a named beneficiary
- Municipal bond interest accrued before death
Correct answer: Traditional IRA balances inherited by a non-spouse beneficiary
Traditional IRA balances represent income the decedent never recognized, making distributions to beneficiaries IRD taxable as ordinary income.
CLU Income Taxation Principles 4
When an employer provides a split-dollar life insurance arrangement under the economic benefit regime, the employee must recognize income equal to: