To find out whether you'll owe tax on life insurance in Pennsylvania, you first have to identify the benefit you receive. You can receive a death benefit as a beneficiary or the cash value as the owner of the policy. A policy owner also can receive a loan from the policy. Two taxes affect life insurance in Pennsylvania: income tax and estate tax.
In most cases, the death benefit from life insurance isn't taxable. However, if you received interest, you pay taxes on the interest on both federal forms and Pennsylvania tax forms. On both forms you would list this under "Interest."
Cash Surrender Value
You pay taxes on the cash value of life insurance policies only if the amount you receive is more than the amount you paid in premiums. You'll receive a Form 1099-R from the insurance company when that happens. On the federal taxes, you list that gain under "Pensions and annuities." On the Pennsylvania tax form, you list the amount under "Interest."
When you borrow from a life insurance policy, you don't pay either federal or Pennsylvania income tax. However, if you surrender that policy later or let it lapse and it has a loan, you might pay tax if the loan amount plus the amount you receive is more than you paid in premiums. Both the federal government and the state of Pennsylvania count loans as received at the time of surrender.
Federal Estate Tax
Life insurance is included in the estate of the deceased if he owned the policy. For the years 2011 and 2012, the federal government gives a $5 million exclusion to all estates. That means that if you add the life insurance to the value of the rest of the estate and it's less than $5 million, there's no federal estate tax.
Pennsylvania Inheritance Tax
Pennsylvania has an inheritance tax rather than an estate tax. This means that you pay according to your relationship with the deceased and the heir pays the tax, although most of the time the executors pay it from the estate. There is no tax on assets going to a spouse. Children and grandchildren pay 4.5 percent, siblings pay 12 percent and everyone else pays 15 percent. The death benefit of life insurance is exempt from Pennsylvania inheritance tax.
- Pennsylvania Department of Revenue: How Does a Taxpayer Report Distributions from a Taxable Annuity or Retirement Plan Before Reaching 59 1/2 on Schedule D?
- Kevin A. Pollock, Attorney: Federal Estate Tax Reform 2011
- The Law Office of Jeremy A. Wechsler: Pennsylvania Inheritance Tax
- Butera, Beausang, Cohen, Brennan: Federal Estate Taxes and Life Insurance: Choose the Owner and Beneficiary Carefully
- IRS: Publication 575 -- Pensions and Annuities