The ability of the IRS to seize money and property to pay tax debts is far reaching. However, its reach does not extend to a taxpayer's life insurance policy once it is paid out to a beneficiary. However, if the taxpayer failed to name a beneficiary or named a minor child as such, the IRS can take the life insurance policy and use the proceeds to pay the deceased insured's back taxes.
Proceeds Not Taxable
If you are the beneficiary of a life insurance policy, you will receive a payout from the policy upon the insured's death. In general, these proceeds are not considered income, so you do don't have to report them as such on your personal income tax return and the IRS will not tax them. However, any interest paid on this money is taxable and must be reported.
Debts Owed by Insured
If the insured owed taxes at the time of his death, the IRS cannot seize the benefits paid to a beneficiary from his life insurance policy. In other words, the IRS cannot seize the money paid to you as the beneficiary of a life insurance policy for debts owed by the person who took out that policy. This is because once the benefits are paid to you as the beneficiary, the proceeds are your property.
When Proceeds May Be Seized
The IRS may seize life insurance proceeds in a few limited circumstances. If the insured failed to name a beneficiary or named a minor as beneficiary, the IRS can seize the life insurance proceeds to pay the insured's tax debts. The same is true for other creditors. The IRS can also seize life insurance proceeds if the named beneficiary is no longer living. In this case, it is as if the policy doesn't have a beneficiary at all.
Protecting Proceeds From Seizure
To ensure life insurance proceeds are not seized by the IRS, the insured can name one or more alternate beneficiaries. In the event the primary beneficiary dies early, this will prevent the policy from being without a beneficiary. The insured could also name as beneficiary a trust, which is administered by a trustee. After the insured's death, the trustee would allocate the life insurance proceeds as instructed by the trust terms. This is a helpful tool for insureds who want to leave life insurance to a minor child.
Based on the West Coast, Mary Jane Freeman has been writing professionally since 1994, specializing in the topics of business and law. Freeman's work has appeared in a variety of publications, including LegalZoom, Essence, Reuters and Chicago Sun-Times. Freeman holds a Master of Science in public policy and management and Juris Doctor. Freeman is self-employed and works as a policy analyst and legal consultant.