Taxes on cashed out life insurance

[CarolToppCPA]

My client cashed out a life insurance policy. and received this information with a check for $5,987.58

"Source of Funds:
$3504.80 Cash Value of Contract
$250.00 Termination Dividend
$2232.78 Accumulated Dividends"

She has no 1099R from the life insurance company only a 1099INT showing $64 of interest on accumulated dividends.

What part of the $5,987.58 is taxable income and where do I report it without a 1099R?

Thanks,

Carol

[CarolToppCPA]

I'll answer my own question...

since I see there are 35 views but no replies.

I called the life insurace company (Prudential) and they wouldn't say much to me because I didn't have Power of Attorney for the client. Pru did say that if taxable income was to be reported a 1099 tax form would be mailed to the client and Pru had no record of a 1099 for this client. Knowing that things get lost in the mail or misplaced by clients, I had the client call Pru.
Another Pru rep told her that since the policy was opened before 1982 and for a small dollar amount, there was no reporting to the IRS. I don't know what the pre1982 or low dollar amount was all about, but the client heard loud and clear that there was no reporting of taxable income to the IRS. We're going with that news and not reporting this life insurance cash surrender. I think that the premiums paid (over 30 years) must have totaled more than her cash surrender.

Carol

[gordman]

What a mess and confusion, I find it hard to admit. The client has the right to get access to correct accurate informations, after all, it's his money we are talking about. Believe it or not I am not surprised to read about this because we can find plenty examples where clients are disrespected.

[Snaggletoof]

A Reply

Carol, only the amount on the 1099 is taxable for the current year, even if the policy is cashed out.

If everyone has done right (and this might be assuming too much), the accumulation spoken of by the insurance has been taxing the policyholder all along over the years.

The policyholder has basis in his "investment" in a life insurance policy. (Sorry, I have words for this kind of investment, but that's another topic). Until the cumulative amount available through cash value EXCEEDS his cumulative investment (premiums paid), then there is really no income to report. At such point in time as this happens, then the amount that accumulates each year, minus the premiums for that year, represent the income for that year alone, and the insurance company should have been issuing a 1099-INT every year. In this manner, his "basis" is equal to the cash value at all times.

Maybe I haven't worded it very clearly, but hope this helps.

[Roland Slugg]

Agree ...

... with Snag. Just report the $64. All other income in excess of basis was (or should have been) reported by the insured on prior years' returns.

Just re-read your post, and the amounts don't seem to add up. The three amounts you listed do total to the check amount, so where is the $64? A separate check perhaps? And what about that $250? When was that received. It would be taxable in that year. The original post doesn't mention any years, and it's a little early to have received any 1099s for 2007, so are we talking about 2007 here ... or some earlier year? In any case, I'd only report was was reported on forms 1099.

[LMathey]

From what I have seen, dividends on life insurance policies are not taxable. However, when those dividends are left with the company to accumulate they earn interest. The interest is then taxable. I would assume the $64 is the interest earned in the current year on the accumulated dividends and is included in that amount.

[Roland Slugg]

You're right

Dividends on life insurance are not currently taxable. They are, in essence, like a return of capital. The taxable amount upon pre-death redemption of a life insurance policy is the excess of the amount received, if any, over the amount paid in. This information may be reflected on the 1099-R form the company should provide.

If the amount received at cash-in is less than the owner's cost/basis, no deduction for the loss is allowable.