Tax TreatmentQuestion 235 of 315
Which statement about the federal tax treatment of a Modified Endowment Contract (MEC) is TRUE?
a.The death benefit of a MEC is taxed as ordinary income to the beneficiary
b.The death benefit of a MEC remains income-tax-free, but lifetime distributions are taxed LIFO with a 10% penalty before 59½
c.Lifetime distributions from a MEC are tax-free up to basis under FIFO
d.Both the death benefit and lifetime distributions from a MEC are taxed as ordinary income
Explanation
The MEC label under IRC §7702A changes the lifetime tax treatment only. Distributions during the insured's life are taxed LIFO (gain first as ordinary income), with a 10% additional tax under §72(v) if taken before age 59½. The death benefit paid because of the insured's death remains excluded from the beneficiary's gross income under §101(a).
Law Reference: IRC §101(a) and §7702APractice all 315 questions free — no signup required.
Related questions on this topic
- An investor purchases an existing $500,000 life insurance policy from the original owner for $40,000 and continues to pay $5,000 in annual premiums until the insured dies five years later. The investor is NOT one of the exempt transferees listed in §101(a)(2). How much of the $500,000 death benefit is taxable to the investor as ordinary income?
- While a non-MEC life insurance policy remains in force, how is an outstanding policy loan treated for federal income tax purposes?
- How are benefits paid from a tax-qualified long-term care insurance contract generally treated for federal income tax?
- A policyowner wants to exchange a $50,000 cash-value whole life policy for a non-qualified deferred annuity. Which statement about the tax treatment is correct?
- A whole life policy fails the 7-pay test and is classified as a Modified Endowment Contract (MEC). Which statement BEST describes the tax consequence to the policyowner?
- A small business pays the premium on a $250,000 group term life policy on a key executive. The business is the policyowner and primary beneficiary. Which statement about premium deductibility is correct?
Last reviewed: · editorial process
Sen Lin, PrepPass Founder · Verified against California Life & Health Insurance License Exam · How we review
Reviewed by John Zihao Zhang — California-Licensed Life Insurance Agent (CA Dept. of Insurance License #4396095 — verify)