What is the tax implication of receiving a cash value from a life insurance policy when it exceeds the total premiums paid?

When a policyholder receives a cash value from a life insurance policy that exceeds the total premiums paid, the amount in excess of those premiums is considered taxable as ordinary income. This is due to the Internal Revenue Code, which states that the gain (the amount received minus the total premiums paid) is subject to income tax.

The rationale behind this is based on the treatment of life insurance policies under tax law. Premiums paid into a life insurance policy are made with after-tax dollars, and the cash value reflects a savings component in addition to the death benefit. When the cash value is withdrawn, the IRS mandates that any gain, representing the growth of that cash value beyond what the policyholder has contributed, be taxed as ordinary income.

This taxation reflects the profits derived from the investment component of the life insurance policy. It's important for policyholders to understand that while the principal they contributed is not taxable, any amount received above that constitutes income and is subsequently taxed accordingly.