“Neither a borrower nor a lender be.” But sometimes clients may ignore Shakespeare’s sound advice in a financial crunch. Unfortunately, as shown in a new case, (Fugler, TC Summary Opinion 2025-10, 11/17/25, taking out a life insurance loan and failing to repay the full amount can have some unintended tax consequences.
Basic premise: If you acquire permanent whole life insurance as opposed to term life insurance, your premium payments build up a cash value in the policy. Generally, you can borrow against the cash value, within certain limits, if you need money in a pinch. For example, a policyholder may borrow against cash value to help pay for an unexpected medical expense.
The policyholder is required to pay back the borrowed money, plus interest, to the insurance company. In effect, it’s like you’re repaying yourself, since this restores the initial death benefit.
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A few other restrictions are likely to apply. Typically, you can’t borrow more than the amount of the cash value or a stated percentage like 90%. But the benefits may be too good to ignore, including quick access to the cash, no closing or application fees and a reasonable rate of interest.
What are the tax implications? Usually, a borrower can avoid any dire tax consequences. However, if you the loan hasn’t been repaid when coverage lapses or the policy is terminated, you may owe a tax bill on part of the amount that you borrowed.
Facts of the new case: A resident of Texas purchased two whole life insurance policies on his life. On one of the policies,, he named himself as the beneficiary. One of his children was named as beneficiary of the other.
From 1988 through 2006, the taxpayer paid annual premiums for each policy. Both policies allowed the taxpayer to borrow against cash value. The interest rate was flexible and payments became due on the policies’ annual anniversary dates.
In 2006, the taxpayer borrowed $10,500 from the first policy and $11,000 from the second. From 2007 through 2016, he didn’t pay any of the required premiums out his own pocket. Instead, he borrowed from the first policy to cover the annual premiums for both of the policies. Interest on the borrowed premiums was added to the loan balance on each policy. Finally, in 2018 the taxpayer requested that both policies be canceled.
Due to the termination, the taxpayer received close to $6,000 from the insurance company. But the company filed Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., stating that the taxpayer had received about $16,000. This reflected the difference between the debt and the taxpayer’s investment in the policies.
When the taxpayer failed to report the full 1099-R amount, the IRS objected. Eventually, the Tax Court ended up ruling in favor of the IRS. Reason: The entire amount reported on Form 1099-R constituted taxable income.
Lesson to be learned: This area contains numerous tax traps for the unwary. Be sure to provide the guidance your clients need relating to life insurance loans.
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Tags: Income Taxes, life insurance, loans
