Multiple Choice
Which of the following is a critical characteristic of good information?
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1. Introduction to Accounting
Useful Information
Multiple Choice
Which of the following statements regarding the taxation of modified endowment contracts (MECs) is FALSE?
A
Death benefits paid from a MEC to a beneficiary are always subject to income tax.
B
Distributions from a MEC are subject to income tax on the earnings portion before age 59½, and may also incur a 10% penalty.
C
Loans and withdrawals from a MEC are taxed on a last-in, first-out (LIFO) basis.
D
Premiums paid into a MEC are not tax-deductible.
Verified step by step guidance1
Step 1: Understand the concept of Modified Endowment Contracts (MECs). MECs are a type of life insurance policy that fails the 7-pay test, meaning the premiums paid into the policy exceed certain limits set by the IRS. This classification impacts the taxation of distributions from the policy.
Step 2: Review the taxation rules for MECs. Distributions, including loans and withdrawals, are taxed on a last-in, first-out (LIFO) basis, meaning earnings are taxed before the principal. Additionally, distributions taken before age 59½ may incur a 10% penalty unless an exception applies.
Step 3: Examine the tax treatment of premiums paid into a MEC. Premiums are not tax-deductible, which aligns with the general tax treatment of life insurance premiums.
Step 4: Analyze the tax treatment of death benefits from a MEC. Death benefits paid to a beneficiary are generally not subject to income tax, which is a key feature of life insurance policies, including MECs.
Step 5: Identify the false statement. Based on the rules above, the statement 'Death benefits paid from a MEC to a beneficiary are always subject to income tax' is false because death benefits are typically tax-free.
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