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Taxable Gain - Surrender of Life Insurance Policy

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    Taxable Gain - Surrender of Life Insurance Policy

    Life insurance policy (a mutual life ins. co.) was cashed out in 2017. Taxpayer received a 1099-R listing a taxable amount of about $12,000, gross cash value was about $14,000 and cost basis, $2,000. Cost basis was difference in total premiums $10,000(paid by parents of taxpayer) and total dividends, $8,000. The taxpayer cashed out the policy in 2017 for financial needs, receiving about $4,000 ( $14,000 cash value less loan debt, $10,000). A letter from the life insurance company explained the taxable gain as the gross cash value less cost basis referring to IRC Section 72. Is the taxable gain correct? Thank you!

    #2
    Probably so.
    It is likely that "total premiums" is not the same as "cost basis" because the policy holder was, along the way, receiving the benefits of having a life insurance policy in place.
    The insurance company is the best source of the information. You just have to deal with the Form 1099-R.

    FE

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      #3
      If the figures that you state are accurate, then the cost basis should be the sum of premiums paid less dividends received (also considered a refund of premiums paid in prior years). For life insurance policies issued by mutual life companies that pay dividends, people tend to ignore that in the basis calculation. If the policy (stock life company) did not pay dividends then that would not be an issue. The outstanding loan and any other charges are simply deducted from the proceeds and don't factor into the taxable gain calculation. So it appears correct IMHO.
      Taxes after all are the dues that we pay for the privileges of membership in an organized society. - FDR

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        #4
        Thank you for the response and help on this matter.
        Carl

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          #5
          Originally posted by ATSMAN View Post
          If the figures that you state are accurate, then the cost basis should be the sum of premiums paid less dividends received (also considered a refund of premiums paid in prior years). For life insurance policies issued by mutual life companies that pay dividends, people tend to ignore that in the basis calculation. If the policy (stock life company) did not pay dividends then that would not be an issue. The outstanding loan and any other charges are simply deducted from the proceeds and don't factor into the taxable gain calculation. So it appears correct IMHO.
          So you're essentially, indirectly, stating that you receive a product (life insurance coverage) at zero cost over the years?? Sounds almost like you're just buying a mutual fund with some "free" life insurance protection tossed in.
          Wish I could do that with my automobile insurance costs.
          I must be missing something.

          FE.

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            #6
            Here you go: https://www.irs.gov/irb/2009-21_IRB#RR-2009-13
            Taxes after all are the dues that we pay for the privileges of membership in an organized society. - FDR

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              #7
              Thanks for the IRS cite. My old brain really can't work through all of that.
              For 2018, I have a client who cashed out what was (may have been) a Universal Life Policy, with second guess a Whole Life policy. Client is in late 60's and stacking the income deck before RMDs arrive. He also does not intend to collect any Soc Sec until age 70.
              At the present time, dependent upon any taxable income from the insurance matter, he intends to do a 2018 Roth conversion +/- based to some degree upon the "income" from the life insurance. I've told him the best answer is to see what will show up on the 2018 Form 1099-R, as the insurance people know all of the relevant details. Only issue there is for tax year 2018 he can't transfer anything from Traditional IRA-->>Roth IRA after 12/31/2018.
              Again, your information is greatly appreciated!

              FE

              Comment


                #8
                Originally posted by ATSMAN View Post
                . The outstanding loan and any other charges are simply deducted from the proceeds and don't factor into the taxable gain calculation. So it appears correct IMHO.
                The outstanding loan WAS factored into the taxable gain calculation. Note it was deducted from the cash surrender proceeds as it had been received at a prior time. (It was not taxable income until such time as the policy was cashed in without the loan being paid back.) It then became a deemed distribution under the IRC rules. The net taxable amount received at termination is reported on Form 1099R and includes the prior loan in the calculation. This treatment was put into place back in the 80's as I seem to recall, when people were trying to use life insurance policies as tax shelters. So given the facts as you have related them, it appears to be correct.

                Comment


                  #9
                  Originally posted by Burke View Post

                  The outstanding loan WAS factored into the taxable gain calculation. Note it was deducted from the cash surrender proceeds as it had been received at a prior time. (It was not taxable income until such time as the policy was cashed in without the loan being paid back.) It then became a deemed distribution under the IRC rules. The net taxable amount received at termination is reported on Form 1099R and includes the prior loan in the calculation. This treatment was put into place back in the 80's as I seem to recall, when people were trying to use life insurance policies as tax shelters. So given the facts as you have related them, it appears to be correct.
                  What I meant was that you don't deduct the loan balance again. It was already accounted when calculating basis. Perhaps I should have been clear.
                  Taxes after all are the dues that we pay for the privileges of membership in an organized society. - FDR

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