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They may not just report $4000 as your taxable income JUST because they got angry ...
However - distribution partially might be classified as your taxable income and the Insurance company is required to report any distribution you take.
First of all - if you took a loan - that is NOT your taxable income as long as it is expected to be paid back.
When it becomes obvious that the loan will NOT be paid back - that amount becomes your income.
If the loan amount will NOT affect your life Insurance balance - that amount is reported as forgiven loan on form 1099C and - in this case it will be your taxable income unless you are eligible to claim any exception (for instance - if you are insolvent)
If the loan amount will be deducted from your life Insurance balance - it will not be reported on 1099C, but will be treated as cashing your life insurance policy.
If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. In most cases, your cost (or investment in the contract) is the total of premiums that you paid for the life insurance policy, less any refunded premiums, rebates, dividends, or unrepaid loans that were not included in your income.
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