Question 32

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

When a policyowner surrenders a policy for its cash value, they incur a tax liability if the cash value exceeds the total premiums they have paid into the policy. This is because the gain realized upon surrender is subject to taxation.

A) The cash value exceeds all premiums paid.

This option is correct as it directly aligns with the tax implications of surrendering a policy. According to tax law, any amount received upon surrender that is greater than the total premiums paid results in taxable income for the policyowner.

B) The cash value is less than premiums paid.

This option is incorrect. If the cash value is less than the premiums paid, the policyowner does not realize a gain, and therefore, there is no tax liability incurred upon surrendering the policy.

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

This option is also incorrect. Exchanging a policy for another of equal value typically falls under a tax-deferred exchange, meaning no immediate tax liability arises as there is no gain realized at the time of exchange.

D) The policy is transferred to a third party.

This option is incorrect as well. While transferring a policy to a third party may have tax implications, it does not directly relate to the scenario of surrendering the policy for cash value. Tax liability is generally incurred upon surrender if there is a gain, not merely due to transfer.

Conclusion

In summary, the correct answer is A, as tax liability arises specifically when the cash value exceeds the total premiums paid into the policy. Options B, C, and D fail to meet the criteria that would trigger a tax liability, making them incorrect choices in this context.