Taxation of Death Proceeds

A lump-sum death benefit is income-tax-free to the beneficiary (exception: the transfer-for-value rule when a policy was sold before death). Paid in installments: principal tax-free, interest taxable. The death benefit is included in the INSURED's gross estate if it is payable to the insured's estate or if the insured held any incident of ownership at death — the right to change the beneficiary, borrow, surrender, or assign (IRC §2042). Giving the policy away removes it — unless the insured dies within 3 years of the transfer, in which case the full face amount is pulled back in (IRC §2035).