What are the tax implications of life insurance death benefits for beneficiaries?

Life insurance death benefits are generally not subject to income tax for beneficiaries. This means that when a policyholder passes away and the beneficiary receives the payout from the life insurance policy, that amount is typically received tax-free. This tax treatment is a significant advantage of life insurance, making it an effective financial tool for providing financial security to loved ones after one's death.

However, there are some nuances to consider. If the policyholder's estate is large enough, the death benefit may be included in the estate for estate tax purposes, but this is different from income tax. The distinction is important; benefits received by beneficiaries in regard to income tax remain exempt, allowing families and dependents to use the full benefit amount without any reduction due to taxation.

The other options present scenarios that do not reflect the typical tax treatment of life insurance death benefits. While estate tax may apply under certain conditions, it does not affect the ordinary income tax treatment of these benefits. Hence, the correct answer underscores the general principle that life insurance death benefits provide direct financial support to beneficiaries without the burden of income taxation.