Question 49

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 arises if the cash value exceeds the total premiums paid into the policy. This means that any gain realized from the surrender is subject to taxation.

A) The policy is transferred to a third party.

This option is incorrect because transferring the policy to a third party does not directly address the tax implications of surrendering the policy for cash value. Tax liability is specifically related to the amount of cash value received in relation to premiums paid, not the ownership transfer.

B) The cash value is less than premiums paid.

This choice is also incorrect, as having a cash value that is less than the premiums paid means there is no gain realized. In this case, the policyowner would not incur any tax liability since they are not receiving more than they invested.

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

This option is incorrect because exchanging a policy for another of equal value typically falls under a tax-free exchange provision. Since there is no cash value received in this scenario, there would be no tax liability incurred.

D) The cash value exceeds all premiums paid.

This option is correct. When the cash value received upon surrender exceeds the total premiums paid, the excess amount is considered a gain and is subject to taxation. This is the point at which a tax liability is incurred.

Conclusion

In summary, tax liability is only triggered when the cash value received from surrendering a policy exceeds the total premiums paid. Options A, B, and C do not address the conditions under which a tax liability arises, while option D accurately reflects the correct scenario where a tax obligation is incurred. Thus, option D is the definitive correct answer.