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The policy in this case was a whole life insurance policy.
Generally, a whole life insurance policy has a cash surrender
value that increases over time as premiums are paid. The cash
surrender value can be distributed to the insured upon the
cancellation, surrender, or termination of the policy before its
maturity date. Upon distribution, a taxable gain may result to
the extent that the distribution exceeds the investment in the
contract; i.e., the amount of premiums paid for the contract.
The record is clear that petitioners canceled the policy and
received the cash surrender value of the policy. Transamerica
then calculated the taxable gain on the distribution based on
petitioners’ cost basis in the policy. Petitioners were well
aware of the fact that the premiums paid affected their cost
basis in the policy and, thus, their taxable gain. In fact, it
appears that petitioners diligently requested Transamerica to
recalculate the taxable gain due to employee contributions that
may not have been accounted for as a result of the conversion of
the term life insurance policies into the policy. Absent
exceptions not applicable in the instant case, the law is well-
settled that a distribution upon the complete surrender of a life
insurance contract is includable in gross income to the extent
the distribution exceeds the investment in the contract.
Therefore, the distribution of $9,760 is includable in
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Last modified: May 25, 2011