Ask the Experts!
The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.
Question: I am recommending key person life insurance on one of the owners of a company. The policy has a chronic illness rider. What are the tax consequences of exercising the rider?
Answer: Section 101 of the Internal Revenue Code says that life insurance death proceeds are usually income tax free. Section 101(g) goes on to say that life insurance benefits paid will be treated like tax-free death proceeds if paid to a chronically ill insured.
The same subsection goes on to define chronic illness in the same way that it’s defined under qualified long term care contracts.
However, if the benefits under a chronic illness rider are paid to a business, Code Section 101(g)(5) says that the special rule, treating the chronic illness benefit as a tax-free death benefit, does not apply.
Therefore, it appears that amounts paid under the rider to a business will be taxed under normal life insurance taxation rules when they are received by the business.
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