8904 / Is a surviving spouse of an employee taxed on the value of death benefits paid under a plan of the employer?

A surviving spouse who receives death benefits payable under a contract, or pursuant to an established plan of the employer, must include such amounts in income.¹ However, if the employee death benefits are payable because of the death of certain terrorist attack victims or astronauts, they may be excluded from gross income.²Frequently, death benefits are funded by insurance on the life of the employee, with the insurance owned by and payable to the employer. These death benefits do not become tax-exempt to the employee’s surviving spouse simply because the proceeds of the insurance policy are received tax-free by the employer. While the employer receives the proceeds as life insurance proceeds, the surviving spouse receives them as compensation payments from the employer.³ As a result, employee death benefits rarely qualify as life insurance benefits wholly excludable under IRC Section 101(a).⁴ Death benefits payable to an employee’s surviving spouse under a split-dollar arrangement, however, may be received free of income tax obligations.

Contractual death benefits are treated as “income in respect of a decedent.”⁵ As a result, where an estate tax has been paid, the recipient of the death payments is entitled to an income tax deduction for that portion of the estate tax attributable to the value of the payments.

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1.Simpson v. U.S., 261 F.2d 497 (7th Cir. 1958); Robinson v. Comm., 42 TC 403 (1964).