tax case
To: Client
Date: September 11, 2014
From: Tax analyst
Subject: Taxpayer Cash surrender value and related tax issues
Issues: Will the cash surrender value of the insurance policy have an effect on his tax return? What are the tax consequences if he cancels the policy in payment of his loan that he borrowed from the insurance company?
Generally, if the owner of the life insurance cancels the policy and receives cash surrender value, he or she must recognize any gain equal to the excess of the amount received over premiums paid on the policy. In this case, the general exclusion provision for life insurance proceeds under Section 101(a) is not applicable because the exclusion only applies to life insurance proceeds paid upon the death of the insured. Thus, the gain of 23,200 (30,000-6,800) that he would receive if he cancels the policy, will need to be recognized as income.
In the matter of using cash surrender value as collateral, the taxpayer, if regularly employs cash receipt method, generally reports income when cash is collected (see Section 1.446-1(a)(3) and (c)(1)(i)). Hence, the 30,000 cash surrender value that he has not actually or constructively received but used as collateral is not considered income, and the loan proceeds taken by the taxpayer against the policy is not considered income as well. From a tax planning perspective, borrowing on the policy’s cash surrender value, the taxpayer can use the policy’s increase in value to pay back his loan without recognizing income, and in this case, canceling the policy will not have any tax consequences on his tax return because the taxpayer will now actually receive zero cash surrender value.
Date: September 11, 2014
From: Tax analyst
Subject: Taxpayer Cash surrender value and related tax issues
Issues: Will the cash surrender value of the insurance policy have an effect on his tax return? What are the tax consequences if he cancels the policy in payment of his loan that he borrowed from the insurance company?
Generally, if the owner of the life insurance cancels the policy and receives cash surrender value, he or she must recognize any gain equal to the excess of the amount received over premiums paid on the policy. In this case, the general exclusion provision for life insurance proceeds under Section 101(a) is not applicable because the exclusion only applies to life insurance proceeds paid upon the death of the insured. Thus, the gain of 23,200 (30,000-6,800) that he would receive if he cancels the policy, will need to be recognized as income.
In the matter of using cash surrender value as collateral, the taxpayer, if regularly employs cash receipt method, generally reports income when cash is collected (see Section 1.446-1(a)(3) and (c)(1)(i)). Hence, the 30,000 cash surrender value that he has not actually or constructively received but used as collateral is not considered income, and the loan proceeds taken by the taxpayer against the policy is not considered income as well. From a tax planning perspective, borrowing on the policy’s cash surrender value, the taxpayer can use the policy’s increase in value to pay back his loan without recognizing income, and in this case, canceling the policy will not have any tax consequences on his tax return because the taxpayer will now actually receive zero cash surrender value.