Modified Endowment Contract Loan

Alan paid $70,000 for a MEC policy when he was 50 years old. What are the income tax ramifications if he takes a $15,000 loan 3 years after purchasing the policy? The policy was worth $78,000 at the time of the loan.

  1. Alan would not have to report any taxable income or penalty.
  2. Alan would have to $8,000 of ordinary income and a 10% penalty.
  3. Alan would have to report $15,000 of ordinary income and a 10% penalty.
  4. Alan would have to report $15,000 of ordinary income but no penalty.