Capital Gains

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Watch out for taxes if you sell your life insurance contract

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The IRS has issued two new rulings addressing the sale and surrender of life insurance contracts from the point of view of policyholders and the investors. In this down economy, it can make good economic sense to sell an insurance policy that is no longer needed, or maybe can no longer be afforded.

The sale of an insurance policy is the sale of an asset; however, the gain could be either ordinary income (taxed like wages) or capital gain income (generally a lower tax rate). You will also need to take into account your investment in the policy (your tax basis).

Now, this discussion does not pertain to someone selling their insurance policy when they are either chronically ill or terminally ill. In those circumstances special exclusions generally will apply.

There are three situations under which you may be selling your policy.

  1. Surrender of the policy to the issuer for cash value.
  2. Sale of the policy with cash surrender value to an unrelated person.
  3. Sale of the policy with no cash surrender value to an unrelated person.

Here are the examples for each situation which demonstrate how the tax bite is determined.

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The Stimulus Plan and New Car Sales

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Last month, President Obama signed the "American Recovery and Reinvestment Act of 2009" -- otherwise known as the economic stimulus act. We're like most tax professionals in that we're still sorting through the Act's nearly $300 billion in tax cuts to see which will be most valuable for you. But we can tell you that it will take careful planning to make the most of the new rules. For better or for worse, the new administration doesn't seem to be making "tax simplification" much of a priority.

Take the new deduction for sales tax on new cars. The concept is simple enough. The auto industry is a huge part of our economy. Car sales have slowed to the point where General Motors stock costs less than a gallon of gas and carmakers are flirting with bankruptcy. Why not give car buyers a tax incentive to stimulate manufacturers?