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 (called 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.
In conclusion, therefore, unless your wife receives a tax reporting document from the insurance company indicating that some of the life insurance proceeds (or dividends) are taxable income, then you may safely ignore this event on your tax return, for tax filing purposes.
