Tax TreatmentQuestion 224 of 315
An owner age 50 takes a $10,000 distribution from a Modified Endowment Contract that has $4,000 of gain over basis. What federal tax result generally applies?
a.$0 taxable; no penalty because life insurance is exempt
b.$10,000 taxable as ordinary income; no penalty
c.$4,000 taxable as ordinary income; no penalty because the owner is under 65
d.$4,000 taxable as ordinary income plus a 10% additional tax on the $4,000
Explanation
MEC distributions follow LIFO, so the first $4,000 (the gain) comes out as ordinary income while the remaining $6,000 is a tax-free return of basis. Because the owner is under 59½, IRC §72(v) imposes an additional 10% tax on the $4,000 taxable portion.
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