Brown v. Comm'r of Internal Revenue, No. 11-2508 (7th Cir. 2012)
Annotate this CaseThe tax court found underpayment of $8,553 on Brown’s 2005 income tax and assessed a penalty of $1,171, based on failure to include income realized upon cancellation of a $100,000 whole life insurance policy, issued in 1982. Brown did not receive any cash upon cancellation; he had already used policy dividends and taken loans to pay premiums. The IRS took the policy’s cash value, $37,356.06 and subtracted Brown’s “investment” of $8,271.76 to arrive at $29,093.30 in taxable income. The Seventh Circuit affirmed. The cash value of a surrendered (whether or not voluntarily surrendered) life insurance policy is includable in gross income to the extent it exceeds the taxpayer’s investment. The fact that this income was used to pay a debt to the insurance company is irrelevant, because it was a personal rather than a business debt and therefore was not deductible. It is also irrelevant that no money changed hands. By surrendering the policy (albeit involuntarily) Brown gave up the prospect of receiving $100,000 if he died but at the same time freed himself from having to pay $1,837 each year to maintain that prospect.
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