Life Insurance Payouts: Taxable In Georgia?

Life insurance death benefits are typically tax-free, but there are exceptions. For example, if the beneficiary chooses to receive the life insurance payout in installments instead of a lump sum, any interest that builds up on those payments could be taxed. Additionally, if a policyholder leaves the death benefit to their estate instead of directly naming a person as the beneficiary, estate taxes may be triggered. It is important to regularly review beneficiaries and policy details to avoid tax complications.

Interest on death benefits

The State of Georgia does not have an inheritance tax, but it did have an estate tax for estates of decedents who died before January 1, 2005. This was based on federal estate tax law, and the tax was paid by the estate before any assets were distributed to heirs. Georgia's estate tax was based on the amount allowable as a credit for state death taxes on the federal estate tax return (Form 706). The amount paid to Georgia was a direct credit against the federal estate tax.

The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 modified the estate tax. For individuals dying in 2002, the state death tax credit was reduced by 25% from the pre-2001 EGTRRA amount; for 2003, the credit was halved; for 2004, the credit was reduced by 75%; and for 2005 and beyond, the state death tax credit was repealed and replaced with a deduction.

Therefore, for estates of decedents who died after December 31, 2004, Georgia estate tax does not apply to any estate with a date of death that occurred in a year for which the Internal Revenue Code does not allow a credit for state death taxes.

Interest accruing for months beginning before July 1, 2016, accrues at the rate of 12% annually. Interest that accrues for months starting on or after July 1, 2016, accrues at an annual rate equal to the Federal Reserve prime rate plus 3%. The interest rate is reviewed and may be adjusted in January of each subsequent calendar year based on the Federal Reserve Rate.

Estate tax

As of July 1, 2014, Georgia does not levy estate taxes or require estate tax returns. However, this does not apply to estates of decedents who passed away before January 1, 2005. For these estates, Georgia's estate tax is based on federal estate tax law. The tax is paid by the estate before assets are distributed to heirs and is based on the amount allowable as a credit for state death taxes on the federal estate tax return (Form 706). The Economic Growth and Tax Relief Reconciliation Act of 2001 modified the estate tax, gradually reducing the state death tax credit until it was repealed and replaced with a deduction for individuals dying in 2005 and thereafter.

If you own a term life insurance policy when you pass away, the death benefit becomes part of your taxable estate. This could push your estate's total value above the federal estate tax exemption, triggering estate taxes. While this generally affects only high-net-worth individuals, some states have lower state estate tax thresholds, so it's important to consider this in your planning. Working with an estate planner can help minimize tax implications and ensure your loved ones receive as much of the death benefit as possible.

Inheritance tax

In Georgia, there is no inheritance tax. However, inheritance may be subject to federal tax if the estate is large enough. Under federal tax law, estates with fewer than approximately $5 million in assets are not subject to estate taxes.

Life insurance proceeds are generally not taxable, but there are some exceptions. If the policyholder names their estate as the beneficiary, taxes may be due. The taxes owed depend on the value of the estate. If the estate is large enough to be subject to federal estate tax, then the life insurance payout will be included in the taxable amount.

Another exception is if the insured and the policy owner are different individuals. In this case, there may be taxes involved if the policy was transferred for cash or other valuable consideration. The exclusion for the proceeds is limited to the sum of the consideration paid, additional premiums paid, and certain other amounts.

If the policy has accrued interest, taxes are usually due on the interest earned.

To avoid taxes on life insurance payouts, the policyowner can set up an irrevocable life insurance trust (ILIT). This separates the benefits from the estate, shielding them from being counted when determining the estate's tax liability. Alternatively, the policyowner can transfer ownership of the policy to another person or entity.

Generation-skipping tax

In Georgia, life insurance proceeds are generally not taxable. However, any interest accumulated on the payout is considered taxable income. If the policy was transferred for cash or other valuable consideration, the exclusion for the proceeds is limited to the sum of the consideration paid, additional premiums paid, and certain other amounts.

Now, here is an overview of the generation-skipping transfer tax:

The generation-skipping transfer tax (GSTT) is a federal tax on gifts or inheritances that prevents the donor from avoiding estate taxes by skipping their children in favour of their grandchildren. The GSTT ensures that grandchildren receive the same amount as if the inheritance was coming from their parents.

The GSTT was introduced in 1976 to close the loophole that allowed individuals to gift money and bequeath property to their grandchildren without paying federal estate taxes. The current version of the GSTT was enacted in 1986 and applies to generation-skipping transfers made on or after October 23, 1986. The tax rate is a flat 40%, and it only applies when the transferred amount exceeds $13.61 million per individual for 2024 and $13.99 million for 2025.

The GSTT is imposed on three types of taxable events: direct skips, taxable distributions, and taxable terminations. A direct skip occurs when assets are transferred from one individual to a skip person, either outright or in trust. The transferor or their estate is responsible for paying the tax. A taxable distribution occurs when a distribution is made by a trust to a skip person that is not otherwise subject to estate or gift tax. The beneficiary is responsible for paying the tax. A taxable termination occurs when an interest in property held in trust terminates, and the trustee is responsible for paying the GSTT.

To avoid the GSTT, individuals can use exemptions, such as the annual gift tax exclusion, which allows individuals to give up to $18,000 per year to an unlimited number of individuals without tax consequences. Married couples can double this amount. There is also a lifetime GSTT exemption of $13.61 million for individuals and $27.22 million for married couples.

By using proper planning strategies, such as dynasty trusts and contributions to 529 plans, individuals can reduce or potentially eliminate the GSTT. However, it's important to note that the provisions relating to the GSTT exemption are set to expire at the end of 2025, and the exemption amount will revert to the lower amount allowed under the 2017 law.

Gift tax

In certain situations, a life insurance payout may be subject to gift tax. This typically occurs when three different individuals are involved in a life insurance policy: the policy owner, the insured, and the beneficiary. In this case, the IRS may view the death benefit as a gift from the policy owner to the beneficiary, triggering a gift tax if the amount exceeds the annual exclusion limit. As of 2024, the annual gift exclusion limit is $18,000, and the lifetime limit (basic exclusion) is $12.92 million per individual.

To avoid gift tax complications, financial advisors often suggest limiting the involvement in the policy to only two parties. This can be achieved by making the insured and owner the same person or by naming the beneficiary as an irrevocable life insurance trust (ILIT). An ILIT ensures that the proceeds are not included in the estate of the insured, allowing the beneficiary to receive the full payout without tax implications.

It is important to carefully plan and structure the ownership of the policy to minimize potential tax liabilities. Regularly reviewing and updating beneficiaries as life circumstances change can also help prevent unexpected tax complications.

Frequently asked questions