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Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22831
Experience:  Taxes, Immigration, Labor Relations
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We had a life insurance policy that they promoted as "being

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We had a life insurance policy that they promoted as "being your own banker" where we paid in large payments over and above the premiums, and they called it paid up additions. The concept to them was that your money was there for extra insurance, it paid your dividends, and you could loan against it, and supposedly the interest on your loans was income to you, since it was your own money. Wrong..
we found out once we had it in place for 7 years and we did that first loan to buy our car cash, and then expected to pay it back only to find they kept the interest, a high rate, and any dividends earned went to pay back the loan. It took awhile, but we figured it out that it was not a great program to be in. We paid in over $80,000.00, earned $14,000 plus in dividends, paid $13,000. plus in interest on our own car loan (our money) and they 1099 us for over $51,000.00 as taxable income. How come I have to pay taxes on money that I already paid taxes on. I understand paying on the dividends, but not the rest. Also, wouldn't the interest paid on our own money offset the gain on dividends? I am totally confused. In my mind, it was a big scam. Please advise.
Submitted: 2 years ago.
Category: Tax
Expert:  Lev replied 2 years ago.

Hi and welcome to Just Answer!

You are correct that if you pay interest to yourself - that may not be treated as taxable income.

However your insurance policy is structured such a way that your loan and your life insurance policy are related - but are still two separate accounts.

The interest you pay on the loan is not deductible because that is considered a personal expenses. However the interest credited to your life insurance policy account - is your taxable income and that is why it is reported on 1099 form.

If you ever surrender your life insurance policy - all interest credited on your account that was reported as your taxable income will be treated as your basis and will reduce your taxable amount.

Unfortunately - such financial product doesn't fit everyone's situation and seems as you made not the best decision.

Now you know what to expect and may better evaluate your situation - so your next step would be to decide if you want to keep that policy or wish to surrender it.

Sorry if you expected a different answer.

Let me know if you need any help or clarification.

 

Customer: replied 2 years ago.

You did not answer the question I had. Key words here, was that we were already 1099'd, so it has been surrendered for the cash value. My total paid in was $80,000 which included the base insurance premium and paid up additions. Over the life of the policy, because you had paid up additions, you would get extra insurance value. What we found was that many companies tell you the projections is say 1,000,000 for exam., but you are only guaranteed the base amount of the policy. Taking that into consideration, as well as the fact that they pocketed our interest on the loan, which was my money, we decided to cash out.

The question though is the amount of $51,000 plus that they reported as taxable income on the 1099. I asked how that could be when we paid in over $80,000. They gave us dividends of over $14,000. but charged us an offsetting expense of over $13,000 in interest on money that was ours. The disbursement went down as follows:

They paid over $5,000. in Federal Taxes, They paid off the loan we had on the books, and they sent us a check for $15,000 plus which was the balance of our paid up additions or cash value on that policy..

How can they say I had taxable income disbursed to me of $51,000. plus, when everything I paid was premiums of one kind or another, and the only income I made was dividend income of $14,000. plus???.

 

Expert:  Lev replied 2 years ago.

1. You need to separate your payments as made to the life insurance policy account and made to the loan accounts. While your life insurance policy was used as a collateral for the loan - these are two separate accounts and you may not mix them together.

2. When you said "My total paid in was $80,000 which included the base insurance premium and paid up additions" - you need to be clear if this amount was paid to the life insurance account or to the loan account or to both. If to both - we need to separate these amounts.

3. Whatever you paid specifically to the life insurance account - is your basis and is recovered tax free. However if payoff is less than your basis - you may not deduct losses.

4. Because the insurance company paid $5,000 in federal income taxes - That amount will be credited against your tax liability on your tax return - and if your actual tax liability is less - you will be entitled for a refund.

5. Dividends credited to your account are taxable and are added to your basis. You may only argue if these dividends were not credited. The fact that your loan payments were used as a source of these dividends is irrelevant. Please be aware that these are qualified dividends and are taxed at reduced long term capital gain tax rate.

They did not say that dividends were disbursed to you - but they were CREDITED to your account - and that is classified as constructively received by you.

6. Please verify what type of expenses you account was charged - if these expenses are in connection of taxable income - they might be deductible as investment expenses of schedule A.

7. If you still think that the insurance company reported dividend income incorrectly - I honestly doubt that - but that is possible - you may ask them to correct the reporting form and if they refuse - you may take the issue with incorrect reporting to the IRS.

 

Sorry if you expected as different answer.

I am sorry about your situation - unfortunately it is very unlikely that you may change anything in their reporting.

Customer: replied 2 years ago.

So, If I am understanding your reply correctly, I should ask for - 1. A detailed statement from them as to the total amount of premiums paid to them. 2. The total amount of dividends paid to me. and 3. The total amount of interest paid on the loan as well as the total amounts paid back on the loan and when it was paid back. 4. The disbursed figure that they wrote on the 1099 is really the total of two things. What was left on our loan balance and what was actually sent to me.

What I don't understand is why they wrote it down as taxable income on the 1099 when they knew it was originally sent in as premiums to them. They know perfectly well what is dividends and thereby taxable. There are columns on the 1099 where they could list the dividends. Is there ever a life insurance policy that they put down it was a sep or simple IRA?? Shouldn't their 1099 have reflected the dividend income so capital gains can be paid??

Expert:  Lev replied 2 years ago.

1. A detailed statement from them as to the total amount of premiums paid to them.

You should have a detailed statement any way - but you may ask if something is not clear.

2. The total amount of dividends paid to me. and

Not just paid - but constructively paid - means - credited to your account.

3. The total amount of interest paid on the loan as well as the total amounts paid back on the loan and when it was paid back.

That is irrelevant because you may not deduct the interest for a personal loan.

 

4. The disbursed figure that they wrote on the 1099 is really the total of two things. What was left on our loan balance and what was actually sent to me.

What I don't understand is why they wrote it down as taxable income on the 1099 when they knew it was originally sent in as premiums to them. They know perfectly well what is dividends and thereby taxable. There are columns on the 1099 where they could list the dividends.

These are perfect question you need to direct to the administrator of your account. I ma sure there are reasons for such treatment - the administrator should provide you with perfect details.

Please be aware that the amount of taxes that they withheld and remitted to the IRS is also included into your total distribution.

Is there ever a life insurance policy that they put down it was a sep or simple IRA??

That is not IRA - as I understood - but if it is marked as an IRA - you need to ask the administrator - that might be an error.

Shouldn't their 1099 have reflected the dividend income so capital gains can be paid??

If these are dividends taxable at the time they are credited - yes - the form should be 1099div. If these dividends were deferred - that is an annuity - and reporting on form 1099R is correct - in this case you may not treat them as qualified dividends.

Let me know if you need any help.

Customer: replied 2 years ago.

The last question--Shouldn't their 1099 have reflected the dividend income so capital gains can be paid? You said if the dividends were deferred that is an annuity - and reporting on form 1099R is correct - in this case you may not treat them as qualified dividends.

They did report this on a 1099R, so are you saying that they are not dividends. At the end of each year, I did get a statement listing the the total amount of paid up additions, the amount I earned as dividends, the amount of our loan balance and the interest rate they are charging, the value of the base policy, as well as its cash value, the value of the dividends to the dealth benefit and its related cash value, the enhanced paid up additions (EPUA) Rider and its related cash value.....but no where did they 1099 me each year for those dividends. They also never listed the amount received by them in premiums each year. I happened to keep a spreadsheet listing the amount I paid each month, that's how I know I paid over $80,000.00 in premiums. So if they are not a qualified dividend, which it says it is in its annual statement, then what is it and how do I report it for tax purposes.

 

And they do have the box checked on the 1099R as a distribution code 7 --IRA/SEP SIMPLE......Technically, they even put the 1099R as distributed to the wrong person. It was a life policy on my husband Jon and they made the 1099R out to me, Susan.

Expert:  Lev replied 2 years ago.

Based on your information - if these are dividends accumulated over several years - not reported every year in which they were credited to your account - that is an annuity - and are not eligible for reduced tax rate.

In this case - you will report your income as annuity income according to 1099R

You will report these amounts on the form 1040 - www.irs.gov/pub/irs-pdf/f1040.pdf

line 16a - total distribution - from 1099-R box 1

line 16b - taxable part of distribution - from 1099-R box 2a

line 61 - federal income tax withheld - from 1099-R box 4

 

Please be aware that payments you made as loan payments - including interest - are personal payments and are credited to the loan account - not to the life insurance account - and you need to account for that separately.

 

According to instructions -

Use Code 7: (a) for a normal distribution from a plan, including a traditional IRA, section 401(k), or section 403(b) plan, if the employee/taxpayer is at least age 59½, (b) for a Roth IRA conversion if the participant is at least age 59½, and (c) to report a distribution from a life insurance, annuity, or endowment contract and for reporting income from a failed life insurance contract under sections 7702(g) and (h).

If the box IRA/SEP SIMPLE is checked - that most likely is incorrect - but as long as you are over 59½, - that will not affect your tax liability.

The most important amount is reported in box 2a - that is your taxable amount.

Let me know if you need any help.

Sorry for confusions.

Customer: replied 2 years ago.

Then we are backed to the same point. The amount listed in 2a is the same as listed in box 1. And that is not the amount of the Dividends. It is the total amount of the Distribution which was my money that we paid for premiums plus the dividends.. Should they not have put the Dividend amount in line 2A?

 

Is there ever a case where they would put a different amount in line 2A that is not dividends?. Is there ever a reason why they would put the whole distribution amount in line 2A? And should they be required to send out a corrected 1099R since they have the wrong taxpayer on it? The wrong info about IRA/SEP.

 

You list the lines to enter the info on the 1040. Is it possible that it is the norm to put the total amount on the 1099R for distribution and you then list the premiums paid to offset the tax on the 1040?

Expert:  Lev replied 2 years ago.

Should they not have put the Dividend amount in line 2A?

The amount in box 2a represents taxable amount - it should be equal to the amount in box 1 minus your investment in the contract.

Is there ever a case where they would put a different amount in line 2A that is not dividends?.

Yes - see above - your after tax contributions into the policy are distributed tax free.

Is there ever a reason why they would put the whole distribution amount in line 2A?

Looks as a mistake... I would contact the administrator and ask for explanation.

And should they be required to send out a corrected 1099R since they have the wrong taxpayer on it?

Yes - you may request for corrected forms.

Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22831
Experience: Taxes, Immigration, Labor Relations
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