Did you invest in stock and sold the stock in brokerage account and than withdraw the fund?
Life insurance proceeds are not taxable.
That is why you received a notice. You need to amend your tax return and report your gain or loss from sale of mutual funds.
Since IRS does not have your cost information, they consider the entire sale price as income and hence the tax liability seems huge.
But if you determine your gain or loss than depending on the gain or loss you may have little or no tax at all.
Yes, you are right. You will owe tax only on the interest or dividend income and on the capital gain that you may have on sale of the funds. Capital gain/loss is calculated as sale price of fund minus the cost price of the fund.