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I am not a licensed tax professional, but I have worked with several tax professionals and have discussed various tax issues with them, so I am familiar with most of the tax concepts with filing, and file many different types of tax returns personally.
The above website describes the basic concepts of the 1099r associated with insurance or annuity distributions:
If at the time your policy lapsed there was an outstanding loan and a taxable gain, you would receive a Form 1099-R. While a policy is active, generally any cash loans or loans to pay premiums would be considered non-taxable. When a policy terminates or lapses, any outstanding loan on a policy with a gain is considered a distribution and becomes a taxable event.
The cause of the tax is the loan outstanding and unpaid interest charged on the loan. You do not present any reason for the loan, so I can't make any judgements on whether the brother took the money from your wife, or for your wife's mother.
good luck. . .
finance guy