Question

Albert had a terminal illness that would require almost constant nursing care for the remaining two years of his estimated life, according to his doctor. Albert had a life insurance policy with a face amount of $100,000. He had paid $25,000 of premiums on the policy. The insurance company has offered to pay him $80,000 to cancel the policy, although its cash surrender value was only $55,000. He accepted the $80,000. Albert used $15,000 to pay his medical expenses. Albert made a miraculous recovery and lived another 20 years. As a result of cashing in the policy:

A. Albert must recognize $55,000 of gross income, but he has $15,000 of deductible medical expenses.
B. Albert must recognize $65,000 ($80,000 - $15,000) of gross income.
C. Albert must recognize $40,000 ($80,000 - $25,000 - $15,000) of gross income.
D. Albert is not required to recognize any gross income because of his terminal illness.
E. None of these.

Answer 1

Albert must recognize $55,000 of gross income from the life insurance settlement, which is the difference between the settlement amount ($80,000) and the premiums paid ($25,000). He may also claim $15,000 of medical expenses as deductions if he itemizes.

Step-by-step explanation:

Albert must recognize $55,000 of gross income due to the life insurance settlement. This is based on the cash surrender value of the policy, which is the amount above what he paid in premiums. The payment from the insurance company ($80,000) minus the premiums paid ($25,000) results in $55,000, which is considered gross income. Although Albert used $15,000 of this money for medical expenses, this does not change the income recognition; instead,

it may allow for a medical expense deduction when he does his taxes, assuming he itemizes his deductions. Thus, the correct answer to Albert's tax situation is A. Albert must recognize $55,000 of gross income, but he has $15,000 of deductible medical expenses.