Many people believe that you do not owe any taxes on the life insurance death benefits. There is some truth to this belief, but it depends upon the value of your entire estate.

Income Tax

Most of the time, your beneficiary will not have to report a death benefit on his income tax return. The beneficiary you name does not owe income taxes on the death benefit because the law contains an exemption for death benefits received from a life insurance policy, regardless of whether the beneficiary is a person or estate. There are some exceptions to this rule that probably do not apply to your policies. But if an exception does apply, your beneficiaries will have to report the death benefit on their income tax returns and pay taxes.

Estate Taxes

The fact that life insurance death benefits are not subject to income taxes is what leads most people to conclude that there are no taxes owing on these benefits at all. This is not always true. Most people are both the insured and owner of their life insurance policies. When you die, the insurance proceeds are paid to the beneficiary or beneficiaries you name in the policy. Even though the death benefit is paid to a beneficiary, it is added to your other property and becomes part of your taxable base, subject to federal estate taxes. Don't panic! Read Chapter 17 to estimate whether you'll owe federal estate taxes.