How is a life insurance death benefit paid as a lump sum to a named beneficiary treated for federal income tax purposes?

Why A is correct

Under IRC §101(a), life insurance death proceeds paid in a lump sum to a beneficiary are excluded from the beneficiary's gross income and received income-tax free. This is one of the core tax advantages of life insurance. However, if the proceeds are paid in installments, the interest element of each payment is taxable, and the proceeds may be included in the insured's gross estate if the insured possessed incidents of ownership. The death benefit itself remains free of federal income tax.

Why the other options are wrong

• B) Death proceeds are not ordinary income to the beneficiary; they are excluded under IRC §101(a).
• C) Capital gain treatment applies to investments sold at a profit, not to death benefit payouts.
• D) Estate inclusion rules depend on incidents of ownership, not on whether the beneficiary is a spouse.

Memory hook

Death benefit = the tax-free gift of life insurance. Lump sum, no income tax.

Why A is correct

Under Internal Revenue Code Section 101(a), proceeds of life insurance payable by reason of the insured's death are generally excluded from the beneficiary's gross income. This tax-free treatment is one of the central advantages of life insurance. If the beneficiary chooses a settlement option that pays interest, the interest portion is taxable, but the death benefit itself remains tax-free.

Why the other options are wrong

• B) Lump-sum death proceeds are not ordinary income to the beneficiary under IRC Section 101(a).
• C) Death proceeds are not treated as a capital asset sale and are not taxed as capital gain.
• D) The proceeds may be included in the taxable estate in some large estates, but that is an estate tax question, not income taxation of the beneficiary.

Memory hook

Death benefit, lump sum, tax-free to the beneficiary. Interest paid on top is what the IRS may reach for.