Life insurance that pays out on the death of an insured person is not taxable unless the policy was turned over to the recipient for a price, according IRS Publication 525. Any amount received in excess of the value of the insurance is interest and is taxable.
When the recipient chooses an installment payout over several years, each payment is considered part insurance and part interest. To determine the nontaxable portion, divide the total payment amount by the number of anticipated payments. Any amount in excess of this is taxable income. Interest is reported on Schedule B or on line 8 of Form 1040 or 1040A, according to the Internal Revenue Service.