Tax TreatmentQuestion 233 of 315
While a non-MEC life insurance policy remains in force, how is an outstanding policy loan treated for federal income tax purposes?
a.It is taxable as ordinary income to the extent the loan exceeds basis
b.It is not a taxable distribution because the owner is obligated to repay
c.It is taxable as a deemed dividend regardless of policy gain
d.It is taxable as a long-term capital gain
Explanation
A loan from a non-MEC life insurance policy is not a distribution and is not taxable while the contract stays in force. If the policy lapses or is surrendered with the loan outstanding, the unpaid loan is treated as a deemed distribution and any gain above the owner's basis becomes ordinary income.
Law Reference: IRC §72(e)Practice all 315 questions free — no signup required.
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Reviewed by John Zihao Zhang — California-Licensed Life Insurance Agent (CA Dept. of Insurance License #4396095 — verify)