Which of the following statements is incorrect regarding the federal income tax treatment of life insurance?

• A. Premiums paid by an individual for their own life insurance are generally not tax-deductible.
• B. If a life insurance policy is surrendered for its cash value, any amount received in excess of the premiums paid is subject to income tax.
• C. Proceeds paid to a beneficiary upon the death of the insured are generally excluded from gross income for federal income tax purposes.
• D. Interest earned on the cash value of a life insurance policy is taxed annually as it accrues.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the context of the question. The problem is asking about the federal income tax treatment of life insurance, and you are tasked with identifying the incorrect statement among the options provided.
2. Step 2: Analyze each statement individually. Start with the first statement: 'Premiums paid by an individual for their own life insurance are generally not tax-deductible.' This is a correct statement because life insurance premiums are considered personal expenses and are not deductible for federal income tax purposes.
3. Step 3: Evaluate the second statement: 'If a life insurance policy is surrendered for its cash value, any amount received in excess of the premiums paid is subject to income tax.' This is also correct because the excess amount represents a gain and is taxable as income.
4. Step 4: Review the third statement: 'Proceeds paid to a beneficiary upon the death of the insured are generally excluded from gross income for federal income tax purposes.' This is correct because life insurance death benefits are typically not subject to federal income tax.
5. Step 5: Examine the fourth statement: 'Interest earned on the cash value of a life insurance policy is taxed annually as it accrues.' This is incorrect because the interest earned on the cash value of a life insurance policy is generally tax-deferred and not taxed annually. Therefore, this is the incorrect statement.