The ‘Getting the @#$% of the Stick’ Case

http://ustaxcourt.gov/InOpHistoric/FEDERMemo.TCM.WPD.pdf

The TP definitely gets my sympathy in this case. She attempted to cancel a whole life policy by sending a letter but instead of cancelling, the insurer started loaning the TP the money to pay the premiums because the policy had cash value. After 20 years of this, the insurer seized the cash value to pay off the premium loan. Part of the surrendered cash value was a return of the taxpayer’s own money but part was accrued interest. The interest portion became taxable income when this event occurred. The TP never received the 1099 because the insurance company did not have a current address so she owed not only tax on money she never received (because it was used to pay premiums) but also owed penalties and interest.

Take aways:

• The TP was deemed to have received the interest income and then used it to pay the insurance premiums (a nondeductible personal expense). If the policy had been cancelled in 1988 she would have had taxable income in that year – but also the cash

• Perhaps we need some legislation that prohibits insurance policies from containing automatic loan clauses which enable them to start attaching the cash value as collateral for premium loans without any further paperwork. Until that day – buyer beware. The TP should have followed up and ensured the policy was indeed cancelled.