Solutions Chapter 3 - 52. Insurance Transfer Joe owes Willy...

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52. Insurance Transfer Joe owes Willy $5,000 from an old gambling debt. Joe knows that there is no way he can repay the debt in the near future. He asks Joe if he will take a $25,000 life insurance policy that has a cash surrender value of $4,200 and release him from the debt. Willy agrees to take the insurance policy and cancels Joe’s debt. Willy makes only one premium payment on the insurance policy of $50 when Joe is killed in an auto accident. Willy collects the $25,000. Explain all the tax consequences of these events for both Joe and Willy. Solution: Joe will have income for the $800 ($5,000 - $4,200) portion of the debt that Willy forgives as part of accepting the cash surrender value of the policy to cancel the debt. When Joe is killed, Willy’s basis in the insurance policy is $5,050 ($5,000 debt + $50 premium payment). He will have income of $19,950 on the collection of the $25,000 from the insurance policy. When a policy is transferred to a third party for money or moneys worth, the receipt
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