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I am working on a story for Think Outside The Tax Box that dives into the recent decision in the case of David and Cindy Fugler, a Tax Court Summary Opinion that gets into the tax effects of the termination of a whole life insurance policy.
Whole life insurance is a tax favored vehicle. The build-up in value is income tax deferred. Proceeds paid on the death, actual or imminent, of the insured are income tax free. And distributions are not taxed until you get your basis back. Still people manage to get into tax disasters from the policies. Some of them are chagrined enough to take it to Tax Court where they almost always lose. This is a round-up of my coverage of the topic going back over fourteen years.
When I reviewed all this I found that there was a case in 2023, that I did not report on. Robert Doggart had insurance policies with loans lapse in 2017 while he was incarcerated. He received 1099-Rs totaling just over $18,000. He did not file at all. He argued that he should not be taxed in 2017, because he did not receive anything in that year. He tried to offset with losses on his personal residence that he was renting to his daughter while he was behind bars. That also failed.
Form 1099-R From Insurance Company Can Be Bad Tax News – June 21, 2016 – Here is the takeaway-
“Now if all that meant was that Mr. Mallory finally paid tax on the $46,300 that he had drawn out over and above his premium, that would have been painful, but really not so bad. That is not the way it works though. The policy loan which liquidated the policy includes all the accumulated interest giving Mr. Mallory proceeds of $237,897.25 which works out to a taxable amount of $150,397.25 yielding a tax of $40,846. That would be 88% of the $46,300. Even Bernie Sanders doesn’t want people to be paying that much.”
Jeffrey Webber’s Cayman Insurance Shelter Nixed By Tax Court – July 2, 2015 – This was an elaborate plan to turn life insurance policies into the ultimate tax shelter. It did not work for income tax purposes but may have succeeded for estate tax purposes.
Another Northwestern Mutual Life Insurance Tax Disaster – February 26, 2014 – A 1979 policy with a substantial loan expired in 2009. Taxpayer conceded that he should be taxed on the amount that he received over the years in excess of premiums, but not over $100,000 in capitalized interest. Tax Court ruled for IRS.
Actuary In Tax Court Beats Northwestern And IRS On Accuracy Of 1099-R – October 31, 2013 – Jeffrey J Furnish purchased a policy from Northwestern Mutual Life in 1972 which he bumped up in 1974. He paid four of the first seven premiums and elected to pay the remaining premiums with policy loans. In 2009 he got a notice from Northwestern to put in more money. He declined and was hit with a 1099-R showing a gross distribution of roughly $78,000 of which $49,000 was taxable. Mr. Furnish challenged NML’s numbers and created enough doubt as to whether the policy actually expired in 2009, that he won the case.
Whole Life Insurance Tax Disasters – June 8, 2013 – I interviewed Charlie Manoog of MSW Financial Planners who had suggestions for how a good agent will help people navigate around these problems. I have another Manoog story with a bit of a tax angle that involves Charlie’s grandfather, who actually had possession of some of the Dead Sea Scrolls and arranged for their sale. Unbeknownst to him, the buyer was the State of Israel.
Unfair Tax Court Decisions On Life Insurance Are Tip Of Unclaimed Property Iceberg – November 4, 2012 – This one is about Scott White who thought he had abandoned an insurance policy when he left his job. The default though was that premiums continued to be paid with policy loans until the cash surrender value was exhausted. Then he got a notice that cost him over $500 in taxes. The interesting question is whether the insurance company would have paid anything had he died during that interim period.
1099s From Insurance Companies – Don’t Ignore But Don’t Take At Face Value Either – September 15, 2012 – This piece covers a taxpayer win. Ronald W Moore had a life insurance policy with Nationwide for which he paid $26 per month for 18 months starting in 1975. The policy stayed in force till 2008 when Mr. Moore was sent a 1099 for $17,941. Looking at the record, the Tax Court determined that the policy probably should have died long before 2008.
Northwestern Whole Life Policy Creates Tax Disaster – Again – January 19, 2012 – This is about Yulia Feder. who had a Northwestern policy that she tried to cancel in 1988. Somehow it lived till 2007 when she got hit with a 1099 for $5,625.
I Still Think The Life Insurance Company Screwed Them – August 9, 2011 – The provocative title is characteristic of my early days of blogging. A financial planner that I knew tried to convince me that people were not getting an unfair deal. I was not thoroughly convinced. The takeaway was – “I agree with Perry’s overall analysis. If you want the income tax benefit of life insurance, you need to drop dead.”
Phantom Income From Life Insurance – August 4, 2011 – A feature of the game of Monopoly is landing on a space where you get to draw a Community Chest Card. One of them has an image of Mr. Monopoly (formerly Rich Uncle Pennybags) who has a long beard and a cane and is bent with age. The card reads Life Insurance Matures Collect $100. I never encountered that as a real world thing until I read about the case of James Ledger. He took out a policy with Prudential in 1974 that paid either on death or on reaching 65. When he turned 65, he got $5,568.11. It is sort of like he landed on the Community Chest square in the ghetto between Mediterranean and Baltic and rolled snake eyes on the next turn, which you and I both know puts you on Income Tax. Like many others he was taxed on capitalized interest in addition to the excess of his money out over his money in.
A Sad Life Insurance Story – January 31, 2011 – Here is the takeaway – “Go figure. This was probably not the outcome that Mr. Sanders expected when he started dutifully paying his $31 per month while we were all worrying about the hostages and cursing the Ayatollah. I hope somebody from New York Life expressed some sympathy.”
Aggressive Life Insurance Plan Fails – Or Maybe Not – August 13, 2010 – This was about a complicated scheme that did not work for income taxes, but may have worked for transfer taxes. The Pension Asset Transfer plan (PAT) would be the subject of an injunction.
Have Some Free Insurance – Not – September 3, 2010 – This is about the case of Gerlie and Patsy Rickard. Their agent fronted them $233,327 to pay the first year premium on a life insurance policy. It would later all fall apart. It happens that the first year commission was greater than 100% and the agent was breaking the rules in doing that. Regardless the Rickards, whose name I have wrong in the post, were still stuck with taxable income from the advance.
Conclusion
The only case I found between 2017 and 2025 was Doggart. That is not to say that I may not have missed some. The Fugler case indicates that the IRS may still be interested in this issue. There are two practical tips. One is to pay attention to any whole life contracts that you have, particularly if you are skipping premiums or borrowing, so you don’t get blindsided. The other is that if you do get blindsided by a 1099-R do not ignore it, but also do not accept it as gospel. The hopeful examples of the Jeffery Furnish and Ronald Moore cases indicate that pushing back on the accuracy of the 1099-R can be the road to victory.
There is a paywall that it is worth getting behind to read some of my deeper pieces and that would be Think Outside The Tax Box.
For great value in continuing professional education be sure to check out Boston Tax Institute