1. IRC §101: Tax-Free Death Benefit

What It Says: IRC Section 101 provides that death benefit proceeds from a life insurance policy are generally income tax-free to the beneficiary.

Why It Matters: This tax exemption allows life insurance to be a strategic wealth transfer tool. It ensures that families and businesses receive the full face value of a policy without reduction from income taxes.

Special Rule: The "transfer-for-value" rule can limit this tax benefit if the policy was transferred to another party in exchange for something of value.

2. IRC §72: Tax Treatment of Withdrawals and Loans

What It Says: IRC Section 72 outlines the taxation of amounts received under life insurance and annuity contracts. Key Provisions:

§72(e): Defines how withdrawals are taxed. For non-MEC (Modified Endowment Contract) policies, withdrawals are treated FIFO (first-in, first-out) — meaning premiums (basis) come out first and are tax-free.

§72(q): Imposes a 10% penalty tax on distributions taken before age 59½ if the policy is a MEC.

Why It Matters: This section is critical to the Infinite Banking Concept, as it allows policyholders to access their cash value via loans or withdrawals, without triggering current tax liability.

3. IRC §7702: Definition of Life Insurance

What It Says: IRC Section 7702 defines what qualifies as a life insurance policy for tax purposes by outlining the necessary relationship between cash value, premiums, and death benefit.

Key Tests:

Cash Value Accumulation Test (CVAT)

Guideline Premium Test (GPT)

Why It Matters: If a policy fails these tests, it loses its tax-favored status under §101 and §72.

This section ensures policies aren’t used merely as investment shelters by placing limits on how much money can be put into them relative to the death benefit.

Bonus: How DEFRA and TAMRA Shaped the Rules

DEFRA (Deficit Reduction Act of 1984)

Introduced IRC §7702.Designed to prevent life insurance policies from being used primarily as tax-deferred investment vehicles. Implemented the CVAT and GPT tests to keep life insurance tax treatment focused on protection, not arbitrage.

TAMRA (Technical and Miscellaneous Revenue Act of 1988)

Introduced IRC §7702A. Created the concept of a Modified Endowment Contract (MEC). If a policy fails the 7-pay test, it becomes a MEC and is subject to less favorable tax treatment (e.g., LIFO taxation and 10% early withdrawal penalties).

Summary

These tax codes form the legal foundation for the powerful financial strategy known as Infinite Banking. When designed properly, a life insurance contract can provide:

- Tax-free death benefit (§101)

- Tax-deferred growth and tax-free access to capital (§72)

- Compliance-based structure to maximize cash value while keeping tax advantages (§7702)

Understanding these sections is essential for using life insurance as a long-term wealth-building and financial control tool.