Treatment of the Sale or Exchange of a Life Insurance Contract—Part I
Posted by William Byrnes on October 19, 2010
Why is this Topic Important to Wealth Managers? Provides general taxation of life insurance contracts that are surrendered, sold or exchanged. Gives examples that are easy to follow and provides an educational foundation for real-world gain determinations.
This is a two-part series in relation to the taxation of life insurance contracts once it is surrendered, sold or exchanged to a third party. The first blogticle will examine the issue from the seller or insured’s perspective, and tomorrow’s blogticle will discuss the matter from the purchaser’s prospective.
An insurance contract that carries a built-up cash value can be loaned against, collected by the beneficiary, surrendered, or sold to a third party. This blogticle deals in particular with the sale or exchange of the contract, i.e., surrendered or sold.
What are the tax implications if the life policy is surrendered?
As a starting point, gross income includes all income from whatever source derived including (but not limited to) income from life insurance contracts (unless the income is otherwise excluded by law). 
In general, a life insurance contract that is not collected as an annuity is included in gross income in the amount received over the total premiums or consideration paid.  “The surrender of a life insurance contract does not, however, produce a capital gain.”  The amount collected over basis is therefore ordinary income.
To read the remainder of this article please see AdvisorFYI.