Life Insurance Proceeds and Tax Withholdings

[ramyun1]

My aunt passed away and I am the beneficiary of her life insurance proceeds in a lump sum payment. I received a 1099-R which includes the Gross distribution (box 1), Taxable amount (box 2a), Fed tax withheld (box 4) and State tax withheld (box 14).  Turbo Tax says that life insurance proceeds are not taxable and seems to imply I do not need to enter the info into the 1099-R section of Turbo Tax.  Furthermore, that section also appears to be designed mainly for IRA, 401K, or pension related withdrawals and rollovers and does not accommodate life insurance proceeds (it starts asking about withdrawals and RMD's which does not apply in my case).  Given this, where do I report the Fed and State tax withholdings? 

I tried entering them in the "Other Income Taxes" section under Deductions & Credits but after Turbo Tax checks my State return it says it cannot e-file my return because I have withholdings from sources other than W2, 1099R, 1099INT, 1099DIV, etc. and I will need to print out and file by mail.

Please advise where I can report my Fed and State tax withholdings while not treating my life insurance proceeds as taxable income.  Thank you.     

[DianeW777]

It depends. The life insurance proceeds reported on the Form 1099-R would indicate it must be included in your tax return as a distribution from a pension or annuity.  

Unless you have distinct and clear and verifiable information to the contrary it should be taxed to the beneficiary. The fact the company issued the 1099-R indicates there is more money in the contract than what was paid for the policy or it was paid for by an employer, as opposed to your aunt.  Depending on the age of the policy and if we assume your aunt paid all of the premiums, there could be substantial earnings that would not be tax free.

Annuities are not life insurance policies but are sold by insurance agents. There are many different investment products that would be taxable as a pension or annuity.  It could help if you find out exactly what type of plan your aunt purchased.

You must include the 1099-R in your income and include the withholding appropriately.

• Life Insurance Proceeds - IRS
• IRS Publication 525 (page 23)

In the end you will decide how you want to handle it, however the IRS will inquire. It can take up to two years, and if they do not agree with you, penalty and interest will accumulate.

[ramyun1]

Thank you for your reply DianeW777.  To add more context the 1099-R was coded as D4 in box 7.  I did try to enter the data into the 1099-R section of Turbo Tax but it then asked questions like when my aunt was born (to determine her age had she lived) and whether the distribution was an RMD or not.  Any suggestion how to answer the RMD question?  That's when it got more confusing because it started treating it like my IRA or pension and after going thru the motions it shows up in my income summary on 2 lines as Pensions - taxable and Pensions - non-taxable even though I am not retired yet.  This all seems puzzling to me.  Will the IRS think I'm retired and drawing from pension even though this was something my aunt had paid for and which I became a beneficiary?  Appreciate any further insight or advice you can provide.      

[DianeW777]

Yes, you can answer yes to the RMD question.  The payer is paying you the required minimum distribution (RMD) as beneficiary.  The IRS will not think you are retired necessarily and based on your age. The IRS requires RMD as a beneficiary and the rules can be reviewed in the link below.

• Retirement Topics

The codes are normal in your situation.

• 4 – Death
• D – Annuity payments from nonqualified annuities and distributions from life insurance contracts that may be subject to section 1411 taxes

The Net Investment Income Tax is imposed by section 1411 of the Internal Revenue Code. The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts. Threshold before this would be included in your return is $200,000 for single ($250,000 for married filing joint).

@ramyun1 

[ramyun1]

Thanks again DianeW777 for the helpful insight and guidance!   I may not fully understand the NIIT but my gross distribution (box 1 of 1099-R) is under the $250,000 threshold and my taxable amount (box 2a) is significantly less than that.  Plus I had Fed & state taxes withheld.  Is there a reason I would still be subject to NIIT taxes?  Does it also depend on my other income as well?  Wish I could have a direct email conversation with you as you seem to really know your stuff 😊.   Thanks again for your help!      

[DianeW777]

Yes, it's possible you could still be subject to the net investment income tax (NIIT).  The modified adjusted gross income (MAGI) is considered which includes other income as well as the 1099-R.  The article below will give more insight to the NIIT.

• What is Form 8960-NIIT?

You're welcome.