Edwina, age 48, owns a modified endowment contract (MEC). Her basis in the policy is $20,000, and the cash value is $35,000. This year, she takes out a policy loan of $10,000. Which of the following statements regarding the income tax consequences of this loan is CORRECT?

A)

Edwina must include $10,000 in her gross income; the $10,000 is also subject to a 10% penalty.

B)

Edwina must include $10,000 in her gross income, but the 10% penalty does not apply.

C)

Edwina must include $5,000 in her gross income; the $5,000 is also subject to a 10% penalty.

D)

Edwina must include $10,000 in her gross income at long-term capital gains rates, plus a 10% penalty.