If John received a one-time distribution of $50,000 from his modified endowment contract, what percentage of that distribution is considered taxable as ordinary income?

In the context of a modified endowment contract (MEC), any distributions taken, including one-time distributions, are subject to taxation under specific rules. When John received a one-time distribution of $50,000 from his MEC, the entire amount is considered taxable as ordinary income.

A modified endowment contract is a type of life insurance policy that has exceeded the IRS limit on premiums paid within the first seven years. Because it is classified as a MEC, the IRS treats distributions from it—whether they are policy loans or withdrawals—as taxable income. This occurs because the investment in the contract is not regarded as a basis in the same way that it would be for other types of life insurance policies, where loans and withdrawals could remain tax-free up to the basis. Instead, the entirety of withdrawals is taxed as income since it is deemed to be a gain derived from the insurance policy.

Therefore, John would be responsible for paying taxes on the full $50,000 distributed, classifying it as 100% taxable income. This tax treatment applies regardless of how much he has paid into the contract, making it crucial for policyholders to understand this aspect of modified endowment contracts when considering withdrawals.