Ms. Cole purchased a $546,000 insurance policy on her own life and named her son as sole beneficiary. She has paid $33,852 total premiums to keep this policy in force. This year, she liquidates the policy for its $42,042 cash surrender value. Does she recognize income on the liquidation? Now assume that Ms. Cole is terminally ill. The insurance policy provides that a person with a life expectancy of less than one year can liquidate the policy and receive 80 percent of the death benefit. She does so and receives a $436,800 accelerated death benefit. Does she recognize income on the liquidation?

Does she recognize income on the liquidation?

Yes, she must recognize the difference between the policy's surrender value and the total premiums paid = $42,042 - $33,852 = $8,190 must be recognized as income.

Does she recognize income on the liquidation?

No, she doesn't have to pay any taxes. Payments to terminally ill policy holders are treated in the same way as death benefits.

For insurance policies that are liquidated, the difference between the cash surrender value and the total premium paid till date, should be recognized as ordinary income. However, when an insurance policy is liquidated for accelerated death benefit due to terminal illness, the proceeds are excluded from taxable income.

Ms. Cole has to recognize an income on the Liquidation as per this calculation here:

Income = Cash surrender value - Total premium paid

=42,042 - 33,852

= $8190

Therefore Ms. Cole should recognize the $8190 of income.

Ms. Cole liquidates the policy and receives 80% as an accelerated death benefit. So, Ms. Cole should recognize $0 of income