A taxpayer was the owner and beneficiary of a $200,000 life insurance policy on a parent. The taxpayer sold the policy to a friend for $25,000. The friend paid a total of $40,000 in premiums. Upon the death of the parent, what amount, if any, must the friend include in gross income?

 

Answer:

$135,000.

Explanation:

The amount that the friend shall include in his gross income shall be the value of the policy ($200,000) less the cost of the policy when sold to him ($25,000) and the cumulative value of the premiums he paid on the policy ($40,000).

Hence, he shall include: $200,000 - $25,000 - $40,000 = $135,000.

The exemption of the insurance shall only be claimed by the original owner and legal beneficiary of the policy. Hence, if the question pertains to the owner of the policy, the answer would have been 0.

To the friend, the policy is an investment, hence any gain on the policy shall be reported as part of the gross income.