Generally, if you receive proceeds under a life insurance contract because of the death of the insured person, the benefits are not includable in gross income and do not have to be reported.
Any interest you receive, however, is taxable and needs to be reported like any other interest received. If the policy was transferred to you for cash or other valuable consideration, the exclusion for the proceeds is limited to the sum of the consideration you paid, additional premiums you paid, and certain other amounts.
For additional information, see IRS Publication 525 Taxable and Nontaxable Income.
If you cash in a life insurance policy, you must include in income any proceeds that are more than the cost of the life insurance policy. Usually, the cost of the policy is the total premiums you paid less any refunded premiums, rebates, dividends, or unrepaid loans that were not included in your income.
You should receive a Form 1099-R showing the total proceeds and the taxable part. Report these amounts on Lines 16a and 16b of Form 1040 or on Lines 12a and 12b of Form 1040A.
To report the proceeds from a policy surrendered for cash: