Exclusions in Gross Income: Life Insurance, Premiums, Retirement, & More

Exclusions in Gross Income: Life Insurance Proceeds, Premiums, Retirement, and More

Gross income refers to the total income earned during a given period, which includes wages, salaries, tips, and other forms of compensation. However, certain sources of income are specifically excluded from gross income due to various tax laws and regulations. In this article, we will discuss these exclusions in detail, focusing on life insurance proceeds, premiums, retirement plans, and pensions.

Life Insurance Proceeds

Unless specified otherwise, life insurance proceeds received by the beneficiary are typically exempt from gross income taxation. Term, whole, and universal life insurance payouts are usually tax-free when they are paid in a single sum to the beneficiary. However, certain situations might lead to the taxability of life insurance proceeds:

• If the death benefit is structured to be paid in installments (for instance, through an annuity), each payment could be subject to income taxation.
• If the policyholder withdrew funds from the policy or took out a loan against the policy and the amount exceeds the total premiums paid, the excess may be considered taxable.
• When surrendering a life insurance policy for its cash value, any proceeds above the policy's original cash basis will be taxed as regular income.
• Employer-paid group life plans with death benefits over $50,000 could potentially be taxable according to the IRS.
• If the deceased person's estate, including life insurance proceeds, exceeds the federal estate threshold of $12.92 million (as of 2023), estate taxes might apply on the portion that exceeds this limit.

Premiums

While life insurance proceeds themselves are generally exempt from gross income taxes, some circumstances can affect the tax treatment of premiums paid for life insurance policies:

• Business-owned life insurance (BOLI) premiums paid by a company can sometimes be deducted as a business expense rather than being included in the employee's gross income.
• Some states allow small employers to purchase key person life insurance policies without including the premiums in their employees' gross income. Consult local tax codes for specific details.
• Certain charitable contributions made to qualifying organizations using a life insurance policy can reduce taxable income.
• When a policyholder takes loans against a life insurance policy, these loans are not considered additional taxable income.

Retirement Plans and Pension Exclusions

Retirement plans and pension contributions are often designed to encourage individuals to save for their future financial needs. As such, they offer significant tax advantages to help people prepare for retirement. Some common types of retirement plans that are excluded from gross income include:

• Traditional Individual Retirement Accounts (IRAs): Contributions to traditional IRAs are tax-deductible while earnings grow tax-free until withdrawn after age 59½.
• Roth IRAs: Contributions are made using after-tax dollars; withdrawals of contributions and earnings can usually be taken tax-free after age 59½ and a five-year holding period.
• 401(k) accounts: Contributions are made using pre-tax dollars, reducing taxable income. Withdrawals after age 59½ and a five-year holding period may be subject to ordinary income taxes.
• Simplified Employee Pension (SEP) IRA: Similar to traditional IRAs but designed for self-employed individuals or small businesses.
• Simple retirement accounts: A simpler version of SEPs that caters to small businesses with fewer employees.
• Health Savings Accounts (HSAs): Contributions can be deductible from gross income; funds grow and withdrawals used for qualified medical expenses during retirement are tax-free.

Inheritances as Exclusions in Gross Income

Inherited property is generally not considered part of the recipient's gross income for federal estate tax purposes. However, if the inherited property generates income, such as rental income or capital gains from selling it, this income might still be subject to taxation at ordinary rates but without any preferential long-term capital gain treatment.

Other Types of Gross Income Exclusions

Other types of income that are excluded from gross income include gifts received by an individual up to $15,000 per year from family members and friends; the first $2,500 of interest received; municipal bond income; and child support payments made for your children under age 18.

Implications for Social Security Benefits

For Social Security purposes, not everything an individual receives is considered income. Some items that are excluded include life insurance death benefit proceeds; gifts and inheritances (unless they generate income); education, scholarships, and other assistance payments; and certain disability benefits.

Educational Resources

For further information on specific exclusions in gross income, refer to the following resources:

• The IRS website provides detailed regulations on life insurance proceeds taxation at.
• The eCFR includes a section on items specifically excluded from gross income at.