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 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.
You should receive a Form 1099-R Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. showing the total proceeds and the taxable part. Report these amounts on Lines 4a and 4b of Form 1040 U.S. Individual Income Tax Return.
To report the proceeds from a policy surrendered for cash:
Note that any link in the information above is updated each year automatically and will take you to the most recent version of the document at the time it is accessed.