In most instances, but not in every single instance, proceeds from life insurance policies (especially those that are "cashed out") are not taxable, or even reportable, on any tax return.

To explain this, we should first understand that Life Insurance is a financial product purchased with after-tax dollars.  Therefore, the payout from a life insurance policy is typically a non-taxable, and non-reportable (that is, disclosed on a tax return), event.

But, there are occasional exceptions.  For example, certain Whole Life Insurance policies invest a portion of the policy premiums in such a way that the policies pay dividends.  These annual dividends are reportable, and taxable, as they then go toward purchasing additional increases in the face value of the insurance policy.

When that is the (annual) case, you should receive a separate tax document from the insurance company (usually a Form 1099-DIV or 1099-INT) for inclusion on your annual personal income tax return.  However, the principal value of the cashed-out policy would not be taxable; instead it would be considered a non-taxable return of capital, and hence, there would be nothing to report on your tax return.

Unless the form you received from your original life insurance company explicitly indicates that some amount is taxable income, then you don't have to report anything from that "cash out" action on your personal tax return.

When it comes to pre-need funeral trusts, the taxation is a little more involved.  Still, there should be nothing that you, as an individual taxpayer, needs to report or file -- or on which you should have to pay personal income taxes.

An excellent discussion on the taxation of pre-need funeral trusts can be found at the following webpage.  The author is a licensed attorney, and all content for the intellectual property remains there with the original writer.

http://corporate.findlaw.com/law-library/simplified-rules-for-taxation-of-preneed-trusts.html


Thank you for asking this important question.