Which of the following statements is true regarding the taxation of dividends in participating policies?

Dividends received from participating life insurance policies are generally considered a return of premium rather than income, which is why they are not subject to taxation. This classification arises because these dividends represent a portion of the premiums paid by the policyholder that are returned due to the insurer's favorable financial performance. Essentially, they are seen as a refund of overpaid premiums, and thus, they do not constitute taxable income.

This principle stands in contrast to other potential options regarding taxation. For example, dividends that are reinvested may raise questions about taxability, but even in such cases, they remain non-taxable under current tax laws. Similarly, dividends are not subjected to capital gains taxation since they do not arise from the sale of an asset but instead are a distribution linked to the insurance policy itself. Consequently, option C accurately reflects the tax treatment of dividends from participating policies.