Question 81

Tax liability is incurred when the cash value exceeds all premiums paid.

When a policyowner surrenders a policy for its cash value, a tax liability is incurred if the cash value exceeds the total premiums paid into the policy.

A) The cash value exceeds all premiums paid

This option is correct because when the cash value of a surrendered policy is greater than the total premiums paid, the difference is considered taxable income. The Internal Revenue Service (IRS) views this excess as a gain, which triggers a tax liability.

B) The cash value is less than premiums paid

This option is incorrect, as no tax liability is incurred if the cash value is less than the total premiums paid. In this scenario, the policyowner does not realize a gain, so there is no taxable income.

C) The policy is exchanged for a policy of equal value

This option is also incorrect because exchanging a policy for another of equal value typically does not trigger a tax event. Such exchanges may qualify for tax deferral under specific provisions of the tax code, meaning no immediate tax liability arises from this action.

D) The policy is transferred to a third party

This option is incorrect in this context as well, since transferring a policy to a third party does not inherently create a tax liability unless there is a gain realized. The tax implications of a transfer would depend on the specifics of the transaction and whether the cash value exceeds the premiums paid.

Conclusion

In summary, the correct answer is that a tax liability is incurred when the cash value exceeds all premiums paid, as this situation results in taxable income. All other options fail to address the conditions under which tax liability arises, either indicating scenarios where no gain is realized or where tax implications do not apply.