Utah Life Producer Practice Exam

What is the tax implication if a corporation collects the benefit from a key person life policy?

1. It is taxed as corporate income.

2. It is subject to personal income tax.

3. It is received tax free.

4. It incurs capital gains tax.

The correct answer is: It is received tax free.

When a corporation collects the benefit from a key person life insurance policy, the proceeds are typically received tax-free. Key person insurance is designed to help a business sustain itself in the event of losing a critical employee. The death benefit from this type of policy does not constitute taxable income to the corporation, which means that the corporation can use the funds for purposes such as replacing the key person, covering the loss of revenue, and other business expenses without facing a tax implication on those proceeds. The tax-free nature of the death benefit is a significant advantage for businesses securing key person policies, as it allows them to effectively manage financial stability without the burden of taxation on the insurance payout. This characteristic makes key person life insurance a valuable asset for corporate financial planning. In contrast, if the key person life insurance proceeds were treated as corporate income, or if they were subject to personal income tax, it would hinder the intended financial support that the insurance proceeds are meant to provide. Similarly, capital gains tax would not apply here, as there are no gains to be recognized from the death benefit itself; the amount paid out is not considered a gain but rather a policy benefit.