Final answer:
If a taxpayer cashes out a life insurance policy before death, the income may be taxable unless they are chronically or terminally ill, in which case certain exclusions may apply.
Step-by-step explanation:
In general, when a taxpayer cashes out a life insurance policy before death, taxable income may result. However, if the taxpayer is chronically ill, the portion of the income required for long-term care is excluded from gross income. If the taxpayer is terminally ill, the proceeds are not taxable. Cash-value life insurance policies, like whole life insurance, provide a death benefit and also accumulate cash value that can be used by the policyholder. These are different from social insurance programs like Social Security and Medicare, which are funded by current workers for future benefits in retirement or if they become sick when old. Such programs pay out for various contingencies, such as medical expenses, death, property damage, or theft. Understanding these policies and the scenarios under which they payout is crucial, especially considering the complexities of tax implications on the proceeds received from these policies.