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Dear Tax Talk,
I want to cash in two insurance policies. One has no tax because the premiums were $20,000 more than the cash value. The second has taxable income of about $14,000 (premiums were paid out as a loan against the policy).
Is each situation separate, or can I combine the excess premiums from the first policy to offset the taxable part of the second policy?
I haven’t come across your unique situation, and after some research, I still don’t have a definitive answer, but maybe an alternative. At the same time, maybe one of my readers can point out an answer that eludes me.
If you cash in both policies during the year, you’ll receive two Internal Revenue Service Forms 1099-R. Each 1099 will show the surrender payment together with your investment in the contract in Box 5. None of the instructions or publications describes how to treat two 1099-R forms. As best as I can tell, each contract would be reported separately, which results in $14,000 in gain with no offset for the loss. There are no provisions for claiming an overall loss on a life insurance contract.
What I suggest as an alternative is to exchange the policies, which would be tax-free. Under the exchange provision, your investment in the insurance contract carries over to the new contract. If you exchange the two policies for one, you’ll end up with a new policy with a slight loss carry-over from your investment in the two contracts. If you later surrender this policy, you will have eliminated your taxable gain and any uncertainty from cashing in the two policies.
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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.