J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

11.18 How Life Insurance Proceeds Are Taxed to a Beneficiary

Life insurance proceeds received upon the death of the insured are generally tax free. However, insurance proceeds may be subject to estate tax so that the beneficiary actually receives a reduced amount (39.8). Interest paid on proceeds left with the insurer is taxable.

Read the following checklist to find how your insurance receipts are taxed—

A lump-sum payment of the full face value of a life insurance policy: The proceeds are generally tax free.

The tax-free exclusion also covers death benefit payments made under endowment contracts, workers’ compensation insurance contracts, employers’ group insurance plans, or accident and health insurance contracts.

Insurance proceeds may be taxable where the policy was transferred for valuable consideration. Exceptions to this rule are made for transfers among partners and corporations and their stockholders and officers.

Installment payments spread over your life under a policy that could have been paid in a lump sum:

Part of each installment attributed to interest may be taxed. Divide the face amount of the policy by the number of years the installments are to be paid. The result is the amount that is received tax free each year.

If the policy guarantees payments to a secondary beneficiary if you should die before receiving a specified number of payments, the tax-free amount is reduced by the present value of the secondary beneficiary’s interest in the policy. The insurance ...