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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.
Question: What is the legal authority for the federal income tax deferred growth of life insurance cash values?
Answer: The fact that the internal cash value growth of a life policy is not subject to income tax was first established in the 1963 Tax Court case of Cohen v. Commissioner.
Since then, Revenue Code Section 7702 was created. That Code Section sets rules for “normal” tax treatment of life insurance—that is, the tax free death benefit and tax deferred growth. Sub-section (g) of 7702 makes clear that if you violate the rules of 7702, you don’t get tax-deferred growth for the cash value:
(g) Treatment of contracts which do not meet subsection (a) test
(1) Income inclusion
(A) In general
If at any time any contract which is a life insurance
contract under the applicable law does not meet the definition
of life insurance contract under subsection (a), the income on
the contract for any taxable year of the policyholder shall be
treated as ordinary income received or accrued by the
policyholder during such year.
Virtually all life companies require their cash value life policies to meet the requirements of Code Section 7702, so that the cash value growth of a permanent life insurance policy is tax deferred.
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