How are gifts of life insurance policies taxed?

Gifts of life insurance policies are subject to donor's tax based on the fair market value of the policy at the time of the gift. This means that when a donor gives a life insurance policy to another individual, the value of the policy, assessed at its fair market value rather than its face value, is what determines the taxable amount for donor's tax purposes.

Fair market value reflects what the policy would sell for on the open market, taking into account factors such as the cash value, the amount of premiums paid, and any loans secured against the policy. This is a crucial distinction, as assessing a gift based on its fair market value aligns with the tax principles governing gifts, ensuring that the valuation accounts for the actual economic benefit being transferred to the donor's recipient.

In contrast, the other choices do not accurately reflect how the IRS treats life insurance policy gifts. The face value of a policy might not correspond to its current market value if the policy is only worth a portion of its face value due to factors like loans or the age of the policy. Simply declaring that policies are tax-exempt would negate the rules governing the taxation of gifts and fail to recognize that donor's tax applies to substantial transfers of wealth. Lastly, stating that only dividends are