cashing in life insurance and tax liability

[lennstrom14]

What is the name of your state? ct
a friend asked me to inquire about a life insurance policy she has ...she has an endowment policy which she is considering cashing in . will she have to pay income taxes on it ..net cash value is : 18,638. total prem paid 10,626.
total interest received and taxes paid on it are : 1282.00

total dividends would be net cash value of 18638 less prem paid 10626 and minus interest
i already paid taxes on 1282 would result in total div of 6730.00...would i owe taxes on 6730...would this be added on income taxes as income or would this be a capital gain and filed on a schedule d form ....thank you for your help.

 

[Betty]

What is the name of your state? ct
a friend asked me to inquire about a life insurance policy she has ...she has an endowment policy which she is considering cashing in . will she have to pay income taxes on it ..net cash value is : 18,638. total prem paid 10,626.
total interest received and taxes paid on it are : 1282.00

total dividends would be net cash value of 18638 less prem paid 10626 and minus interest
i already paid taxes on 1282 would result in total div of 6730.00...would i owe taxes on 6730...would this be added on income taxes as income or would this be a capital gain and filed on a schedule d form ....thank you for your help.

You did the calculations exactly right. $6,730 of the proceeds/cash surrender value would be the amt. taxable. It will be subject to federal income tax as income & taxed in the yr. the income is received.

 

[efflandt]

Typically the insurance company would withhold 10% of the "taxable" amount towards federal income taxes when the policy is surrendered (unless a form is filled out to not withhold), plus some towards state tax in a few states. But if more than $1000 tax is due at federal filing time, there might be a penalty for underwithholding.

So your friend should probably do a hypothetical return, even if based on 2006 income, to get an idea of tax owed for that income minus the 10% withholding, to see if they might need to adjust W-4 form or do an estimated tax payment.

For information about whether an underwithholding penalty might apply if too much is owed at tax time, see page 62 of 1040 instructions about line 77 Estimated Tax Penalty. If there could be a penalty, see 2007 W-4 form/instructions if that person works for an employer, or 1040-ES form/instructions if not, so enough is withheld or paid to early enough to avoid the penalty.

Also check whether there is an underwithholding penalty for state taxes.

PS: I surrendered a whole life policy in 2005, but also had IRA to Roth conversions, so figured everything out on a spreadsheet and did a W-4 adjustment to owe about $600 at filing time.