Question

Twenty years ago, Mr. Wallace purchased a $250,000 insurance policy on his own life and named his daughter as sole beneficiary. He has paid $14,250 total premiums to keep this policy in force. This year, he liquidates the policy for its $20,000 cash surrender value. Which of the following statements is true?A) Mr. Wallace recognizes $5,750 capital gain on the liquidation.B) Mr. Wallace recognizes $5,750 ordinary income on the liquidation.C) Mr. Wallace recognizes no gain on the liquidation.D) Mr. Wallace recognizes $20,000 ordinary income on the liquidation.

Answer 1

Answer: Mr. Wallace recognizes $5,750 ordinary income on the liquidation

Step-by-step explanation:

From the question, we are informed that Mr. Wallace bought a $250,000 insurance policy on his own life and then named his daughter as the sole beneficiary twenty years ago. He has paid $14,250 total premiums to keep this policy in force and he then liquidated the policy for its $20,000 cash surrender value.

This means that Mr. Wallace recognizes ($20,000 - $14,250) = $5,750 ordinary income on the liquidation.

It can't be a capital gain because capital gain is the rise in an assets value when its sold. A life insurance policy is not an asset. Therefore, Mr. Wallace recognizes $5,750 ordinary income on the liquidation (option B) is the right answer.