A Modified Endowment Contract (MEC) is defined as a policy that fails the seven-pay test. What are the tax consequences for distributions from a MEC?

A Modified Endowment Contract (MEC) is defined as a policy that fails the seven-pay test. What are the tax consequences for distributions from a MEC?

• A. Distributions are tax-free if the policy remains in force.
• B. Distributions are taxed as capital gains only.
• C. Distributions are taxed as ordinary income to the extent of gains; withdrawals before recovery of gains may be penalized in other contexts.
• D. MEC status converts all benefits to tax-deductible.

Answer: (C)