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Premiums paid into the policy are reduced by the dividends earned by the policy for the purposes of calculating the cost basis (or tax-free amount). The taxable gain is the value of the contract reduced by the cost basis. Thus, the smaller the cost basis, the larger the taxable gain.
The taxable amount is based on the guaranteed cash value - not the proceeds. The guaranteed value includes the amount of the surrender as well as any unpaid policy loans.
Dividends are not taxable when they are earned since they are a return of premium. When the policy is surrendered, the taxable gain calculation includes the dividends. However, since we already reported the tax on the interest every year (Form 1099-INT), the interest is excluded from the taxable gain calculation.
You receive the tax form due to the following:
We do not determine your eligibility for hardship or other special tax treatment. You would provide the IRS the required information when you file your tax return. The codes used reflect your age at distribution.
IRS regulations require the full value of a traditional policy to transfer at the time of the issue of the universal policy.
If a policy has a loan and it lapses for non-payment of premium, the policy’s non-forfeiture provision goes into effect (either ‘Paid-up’ or ‘Extended Term’). The loan is then forgiven, but a reportable event occurs. IRS regulations require that we report the gain on policies that enter their non-forfeiture provision when there is an outstanding loan.
We must report the distribution if it was a direct payment to you. It is up to you to show that you deposited the money into an allowable product (e.g., IRA) within the 60-day time period. A 5498 from the receiving company should be issued.