Question

Laura recently was diagnosed with cancer and has begun chemotherapy treatments. A cancer specialist has given Laura less than one year to live. She has incurred sizable medical bills and other general living expenses and is in need of cash. Therefore, Laura is considering selling stock that cost her $35,000 in 2005 and now has a fair market value of $50,000. This amount would be sufficient to pay her medical bills.

However, she has read about a company (VitalBenefits.com) that would purchase her life insurance policy for $50,000. To date, Laura has paid $30,000 in premiums on the policy.

a. Considering only the Federal income tax effects, would selling the stock or selling the life insurance policy result in more beneficial tax treatment?
b. Assume that Laura is a dependent child and that her mother owns the stock and the life insurance policy, which is on the mother's life. Which of the alternative means of raising the cash would result in more beneficial tax treatment?

Answer 1

A. The sale of the stock by Laura will end in a $15,000 ($50,000 amount realized − $35,000 adjusted basis) financial gain. However, Laura's financial gain rate could also be 0% if she is within the 10% or 15% marginal tax brackets. If she is within the 25% or greater marginal tax brackets, her alternative rate are going to be 15%. So her liabilities on the $15,000 financial gain might be either $2,250 ($15,000 × 15%) or $0 ($15,000 × 0%). If Laura is diagnosed as "terminally ill," the realized gain on the life assurance policy of $20,000 ($50,000 − $30,000) is excluded from her gross income.

B. Capital gain treatment would apply to the sale of the stock by Laura's mother. The $20,000 realized gain on the life assurance policy are going to be included within the gross income of Laura's mother. Laura's mother cannot qualify for the exclusion because she isn't terminally ill. The mother's recognized gain of $20,000 won't be eligible for financial gain treatment because cashing within the life assurance policy isn't considered a "sale or exchange," which may be a requisite for financial gain treatment. no matter how the medical bills are financed, Laura's mother are going to be allowed to require an itemized deduction for the medical expenses paid (less the AGI floor) for her dependent daughter, assuming she itemizes her deductions.