Distributions (including loans) from life insurance contracts classified as Modified Endowment Contracts under the IRC are taxed gain-out-first
While the death benefits from a life insurance contract are generally tax-free, interest may be paid from the date of death until the claim is settled. The IRS requires that we report the interest you earned on Form 1099-INT.
If you receive income that is reported on Form 1099–R you cannot use Form 1040EZ. Generally, distributions from life insurance and annuity contracts are reported under the category of “pensions and annuities” on lines 12a and 12b on the Tax Form 1040A (11a and 11b if an IRA distribution) or lines 16a and 16b on Tax Form 1040 (15a and 15b if an IRA distribution).
Generally, the gain reported on the full or partial distribution of a life insurance or annuity contract is considered ordinary income. There are some situations in which the proceeds are treated as capital gain, e.g. the life insurance contract was sold by an owner to another party. If you feel your transaction may qualify for capital gain treatment you should consult with your tax advisor.
There was a loan on my life insurance contract when it was surrendered/lapsed
For any part of a transaction to be taxable, the contract must first have a gain. A life insurance contract has a gain when the gross cash value exceeds the cost basis (generally premiums paid less adjustments) of the contract.
Generally, when a taxpayer takes a payday loans CA distribution from a life insurance contract the IRC allows the taxpayer to recover the cost basis before any gain is withdrawn, but there are some exceptions. Also, distributions from a contract within the first 15 contract years may be subject to gain-out-first taxation depending on the size of the withdrawal and other factors.
The IRS requires that if a loan is outstanding when a life insurance contract is surrendered or lapses, the taxable amount reported is generally determined by comparing the gross cash value of the contract to the remaining cost basis.
I exchanged my life insurance contract for another life insurance contract. Why did I receive a Form 1099–R (or possibly two Forms 1099–R)?
The transaction is reported as if the gross cash value were distributed at the time of the surrender or lapse and then used to pay off the loan; the remaining value, if any, is distributed to the contract owner
The IRC allows certain exchanges (section 1035 tax-free exchanges), to occur without generating taxable income even though one contract is surrendered for another.
- If you exchanged your Northwestern Mutual contract for one with a different company, and the exchange qualified as an IRC section 1035 tax-free exchange, a Form 1099–R was generated showing a Distribution Code of “6” in Box 7. This provides the cost basis transferred (amount in Box 5) to your new contract as part of the exchange. No taxable amount is reported in Box 2.
- If you received two Forms 1099–R for the same contract on the exchange from Northwestern Mutual to another company, the exchange was not entirely tax-free. One Form 1099–R will report the amount of taxable income generated from the exchange (Distribution Code of “7” in Box 7), which occurs if you received cash or an outstanding loan was extinguished as part of the exchange. The other Form 1099–R reports the cost basis transferred (Distribution Code of “6” in Box 7) to the new company. If you exchanged one Northwestern Mutual contract for another Northwestern Mutual contract under IRC section 1035, we do not send a 1099–R with a Distribution Code of “6”as Northwestern Mutual tracks the cost basis internally.