I'm not a CPA, but a whole life insurance holder so I have done some research on things like this...... someone else should confirm, but you should make sure that a basis is tracked in relation to your surrender (may reduce amount of tax you owe).
If I understand correctly, all premiums paid count as a basis that is subtracted from the amount cashed out to determine how much is subject to tax. And then it should be taxed at your general income tax rate I believe. I would imagine any penalty might be related to a tax underpayment if you didn't pay tax on the proceeds of the cash out and/or you have lots of proceeds (either in reality or due to untracked basis).
I haven't cashed out my own life insurance policy yet and have been debating doing so. So I'd really love to know what a true expert has to say on this.
You shouldn't be taxed on the entire surrender value. You’ll be taxed on the amount you received minus the policy basis, which is amount of premiums that you paid. This taxable amount reflects the investment gains that you took out. Tha fact you received Form1099-R from your insurance company means that your insurance policy wasn't general life insurance, it was an annuity and it could be a subject 10% early withdrawal penalty.