Tax TreatmentQuestion 235 of 315
Which statement about the federal tax treatment of a Modified Endowment Contract (MEC) is TRUE?
a.Both the death benefit and lifetime distributions from a MEC are taxed as ordinary income
b.Lifetime distributions from a MEC are tax-free up to basis under FIFO
c.The death benefit of a MEC is taxed as ordinary income to the beneficiary
d.The death benefit of a MEC remains income-tax-free, but lifetime distributions are taxed LIFO with a 10% penalty before 59½
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
PrepPass Editorial Team · Verified against California Life & Health Insurance License Exam · How we review