How Does a Life Insurance Company Determine If Back Taxes Are Owed?
When you receive proceeds from a life insurance company, the company makes no determination regarding back taxes you may owe. Those proceeds are not subject to taxation unless they include interest on the funds. Life insurance benefits are protected from judgments, but the IRS may be able to take the cash value of insurance benefits if you owe back taxes. The IRS also may attach the funds if you deposit them in a bank account that has an IRS levy.
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Death Benefits
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The IRS can attach almost anything to satisfy a levy. That includes life insurance proceeds when you're the beneficiary. In most cases, the IRS is not aware you're a beneficiary of an insurance policy. Even if it is, according to the IRS collection process, it attaches death benefits only in extreme cases. While the IRS may not be aware of the proceeds, if there's a levy against your bank account, you might lose your funds. If you deposit the benefits check in the account, the insurance money becomes part of the bank account and can be attached by the IRS.
Cash Value
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If the IRS notifies you of a potential levy on your assets because of back taxes, it has the right to attach the cash value of life insurance policies you own. In this case, the IRS sends two letters: One is a demand for payment, and the other is an attempt to levy. If the IRS is aware you have life insurance with cash value at a specific company, it can attach the cash value up to the available loan amount to satisfy the payment.
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How Does the Life Insurance Company Know?
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The life insurance company has no knowledge of your tax situation until it receives a notice from the IRS regarding the intent to levy. The insurance company must hold the funds for 30 days before release to give you time to satisfy the demand. If you do, you need to make certain the company receives a release of the levy.
Owing Back Taxes with No IRS Levy
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If the IRS does not notify your insurance company of a levy or you haven't received a notice of intent to levy, an insurance company will not be aware you owe back taxes unless you tell the company. However, even if you do inform the insurance company, unless the IRS orders the insurance company to send the funds, the company takes no action on this matter.
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