I surrendered a cash value life insurance policy in Delaware,can the state tax the proceeds?

[Carl]

It depends. What you cashed out is referred to as a "whole life" policy, which in my opinion are an absolute waste of money. (But we all know what opinions are like.)
There are many different types of whole life policies. If your policy earned dividends or interest, then those earnings will be taxable. The insurance company will send you the appropriate tax reporting document if this is your case. Understand also that even if the earnings were used to buy additional paid up insurance, they are still taxable income to the policy owner.
A few years back I cashed out a $100K whole life policy that I'd originally purchased back in 1991. I got a check for $47K. Of that 47K, $12K was earnings of some type or another, and I received a 1099-R reporting that income to me.
So you might want to contact the company to inquire if any tax reporting documents will be issued to you, and see if you can at least get an approximate amount of the taxable portion of the payout, if there is a taxable portion at all.

[SweetieJean · Accepted solution]

If the Cash Surrender Value more than the total premiums paid, and you surrender the policy (cancel it), the excess is earnings and taxable income. For example, if you paid $1,000 in policy premiums for 20 years and you cash in the policy and receive $30,000, you'll pay ordinary income tax on $10,000 in earnings.  This is true for both Federal and Delaware.

[SweetieJean]

This assumes you were a Delaware resident at the time of surrender.

[Carl]

The cash surrender value will never be more than the premiums paid. But regardless, any earnings are reportable income in the tax year they're paid. Weather they're taxable or not is a different issue. The earnings have to be reported, and the payor will issue the appropriate tax reporting document to report those earnings, tax time. Most common document issued is a 1099-R. But it could be a 1099-INT, 1099-DIV, or anything. It just depends on how the earnings are classified.

[SweetieJean]

@Carl  I've had policies where the CSV is indeed more than the premiums paid, because of accrued earnings that are not taxable until the policy is paid.

[TomD8]

If you surrender your cash value life insurance policy, any gain on the policy will be subject to federal (and possibly state) income tax. The gain on the surrender of a cash value policy is the difference between the gross cash value paid out (plus any loans outstanding) and your basis in the policy. Your basis is the total premiums that you paid in cash, minus any policy dividends and tax-free withdrawals that you made.  The insurer will most likely send you a 1099-R showing the total proceeds and the taxable part.

[Carl]

SJ - Accrued earnings are exactly what I'm talking about. Those earnings can be in the form of interest, dividends, or other possible types. On my WL policy accrued earnings were used to buy additional paid up insurance. But when I cashed out those earnings were still taxable, because what I used them for didn't matter. They were taxable in the year I cashed out, even though I didn't actually receive that money anyway. (It had been used to buy additional paid up insurance as they accrued.)

[McK1234]

What if the policy was originally issued in Delaware, but the person lives in another state.  Which state should they pay the state taxes to?

[TomD8]

"Which state should they pay the state taxes to?"

To their state of residence at the time the proceeds are received.