Need tax help about an 1099-R from a life insurance policy surrender that had a loan against it

[Thankful]

A Life Insurance Company (XXX Co.) sent me a 1099-R that said that I received from them a total distribution of $6903.05. I did not. I received $2834.98. 

Further explanation of my case and the unusual circumstances surrounding it: In 1947, when I was 1 year old, my mother bought a life insurance policy for me from XXX Co. for an $11 annual premium. I knew nothing about this until XXX Co. located me in 2018 when I was 71 years old and told me the policy on me existed. (Apparently the government had passed some kind of law requiring life insurance companies to notify people like me about the existence of such policies.)  XXX Co. told me that my mother (deceased in 1977) had put in place some kind of an automatic loan-against-the-principal payment plan. This meant that if ever a premium payment was missed, the payment would be automatically made by a loan and the policy would not lapse. So, when my mother died in 1977 payments began to be automatically made by a loan from XXX Co. Interest on the loan accrued from then until 2018 (over 40 years) and the loan amount grew to over $4000.00. When I learned about the policy for the first time in 2018, I was told I could pay back the loan amount in full and stop the interest accrual and thus restore the policy to its original value. I decided just to surrender the policy for whatever it was worth after the “loan” was paid off, and be done with the whole matter. XXX Co. then sent me a check for $2834.98. 

This year, I was shocked to receive the 1099-R for $6903.05 from XXX Co. This causes me to have to pay an additional $700 in taxes. Again, I knew absolutely nothing about this policy or its ongoing “loan.” I should not have to report income that I never received and pay taxes on it. I did not take out the loan and the insurance company never notified me about what was happening for over 40 years!  I do not have a tax accountant to advise me and do not want to have to find one and throw several hundred more dollars at a problem I did not create.

A friend who owned a life insurance company advised me only to report as income only the amount of money that I actually received from XXX Co. and to write an explanatory letter to the IRS and attach it to my XXX Co. 1099-R. He felt that this would be sufficient and save me the additional cost of an accountant to advise me.

Here is the only way I could figure out how to use Turbo Tax Premium (which I purchased and downloaded) to recalculate my taxes using the amount I actually received from XXX Co.: I had to change the XXX Co. 1099-R Form in Turbo Tax like this: Box 1-Gross Distribution changed from $6,903.05 to $2,834.98  Box 2-Taxable amount changed from $6150.70 to $2082.63 ($2,834.98 – $752.35 found in box 5). I left Box 5-Employee contributions/Designated Roth contributions or insurance premiums:  $752.35 as it was.

I am concerned about putting amounts in Boxes 1 and 2 that are different than what XXX Co. has reported to the IRS. I called XXX Co., but they will give me no tax help or advice. I plan to include a letter to the IRS explaining why I changed the 1099-R amounts and also a copy of the check I received from XXX Co. Can someone help me understand if this is the best way to try and address my problem or if I should do something else. John 

[NCperson]

First, I am always loathe to change amounts on forms that are received from others for 2 reasons

1) that form is reported to the IRS and they probably will do a match against your return, and if the mounts don't match, it would cause an audit (which could be as simple as a letter requiring the tax on the difference be paid)

2) any penalties assessed will not be covered by the Turbo Tax guarantee because you did not input the document as received.  "garbage in / garbage out' will be their argument

Sounds like what you really have for income is the accumulated value of the policy over its face value, less interest expense associated with the money "you" borrowed over the years. 

Did you receive the payout of the life insurance proceeds? meaning the face value of the policy?  That is not taxable, but it was not mentioned in your post that in return for that $4000 loan from the Insurance Company, you did receive something of value that should be much more than the $6,000!  

The income has been reported to the IRS (the $6000) but then the interest from the loan is not deductible because it's not secured by real property.  

What you just may have to do is just rationalize that while you reported $6000 of income and paid some tax on it and then less the $4000 to pay off the 'loan' there is still found money in your lap that you didn't know you would ever receive but it is more than the zero you had before you knew it existed! (plus I suspect you received the policy value tax free right?????)

While my advise is 'free' so it the advice from your Life Insurance buddy.  Can he document for you that changing the amount that the insurance company reported to the IRS is the right thing to do?

The Insurance company is reporting the amount they did because it technically is the income you received and under the terms of the contract.  And further under the terms of the loan contact  you had to borrower the money to protect the accumulated value which is exactly what appears to have occurred. 

sorry as that is probably not what you wanted to hear.  Anytime folks have challenges with figuring out TT, it's normally because TT is programmed to follow the IRS rules and trying to circumvent those rules causes the user to 'fight' with the TT software. 

[Thankful]

Thanks for your thorough and thoughtful reply. The policy was not a payout because I am still alive. I surrendered the policy and the insurance company took $4200.00 of its surrender value to pay off the loan that had been growing for 40 years. I think the original policy payout was supposed to be $7000.00.  I got $2800 and the government will be getting $1147 of that. My wife and I have decided just to go ahead and pay up and be thankful for the money we did get, rather than what we had to give to the government. I just posted on the Better Business Bureau website--in the place for company reviews--what happened to us with this company (The Savings Bank Mutual Life Insurance Company of Massachusetts). It should appear there in a few days. One statement I made was: "What a great deal for them. Sell a policy and at payout, they pay themselves back the loan they initiated and kept in place for 40 years because my uninformed and unsuspecting mother signed the line that said they could, and because the government didn't have a regulation that prevented their greedy behavior." It appears that the only way we could have avoided a tax situation  was to payoff the loan out of pocket and after my death my beneficiary would have received the payout tax free. In my opinion, SBLI should have given us some kind of high level explanation about the tax impact before we surrendered the policy.

[billjans]

I have a similar problem with a 1099-R that I believe is incorrect.  However, reporting different numbers to the IRS is not advisable, as a previous respondent said.  If you cannot get an acceptable explanation from your insurance company, I suggest filing a complaint with the Better Business Bureau.  That may at least get you an answer as to why the numbers on the 1099-R are what they are.