Ana paid $30,000 in premiums on a non-MEC whole life policy. She surrenders the policy for $48,000 in cash. How is the surrender taxed?

Explanation

Under IRC §72(e), a surrender of a non-MEC life insurance policy uses cost-recovery treatment: the policyowner first recovers her cost basis (total premiums paid, less prior dividends taken in cash and less any nontaxable distributions), and only the excess over basis is taxable. Here basis is $30,000 and cash received is $48,000, so $18,000 is taxable. That gain is taxed as ORDINARY INCOME — the response calling the $18,000 a long-term capital gain is wrong because life insurance inside-buildup is never capital gain. Treating the entire $48,000 as ordinary income ignores basis recovery, and calling the entire $48,000 tax-free ignores the $18,000 gain. This is the standard 'cost-recovery first' rule that distinguishes non-MEC life insurance from MECs (which are taxed LIFO/gain-first under §72(e)(10)).