How to Pay Income Tax on a Life Insurance Policy
- 1). Review the death benefit policy. This is the agreement that is sent to you when the life insurance policyholder dies. It comes with several options. The most popular and common options are lump-sum payments and installment payments. A lump-sum payment disburses the full amount of the policy and installment payments allocate the benefit over a number of years.
- 2). Look at the agreement for any special considerations. If the proceeds are designated to pay some debt, you may be liable for taxes. For example, if you are beneficiary on a policy that is scheduled to pay off a mortgage loan when it comes due, the proceeds become taxable.
- 3). Find out if you are receiving any interest payments on the death benefit. Any interest paid to you, in addition to the total death benefit, is taxable. This amount should be broken out in the death benefit agreement you received. The interest, however, will be broken into years if you choose an installment method of payment.
- 4). Report the total death benefit on your following year's taxes. If the income is not taxable, report it on Line 21 on your 1040 return. If the death benefit is taxable, you will need to report it on Line 8a. Review the final 1040 with a CPA (Certified Public Accountant). You'll want to make sure you are accurately reporting the income.
- 5). Complete the 1099-R if you are receiving interest payments on the life insurance payout. You will also need to report this income on Lines 16a and 16b on your 1040. See Resources for a sample 1040 form, with instructions.
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