Life Settlement Taxation

Life settlement taxation has historically been somewhat ambiguous as the life settlement industry was relatively new. Even though CPA's and accountants had a generally accepted method for calculating taxes on life settlements, no definitive guidance was previously provided by the Internal Revenue Service until the summer of 2009. Then the IRS issued a ruling specifically addressing the computation of life settlement taxes resulting from the sale of a life insurance policy. Life settlements completed on or after August 26, 2009 will now be subject to Revenue Ruling 2009-13 life settlement taxation guidelines.

Life settlement taxation of transactions completed prior to August 26, 2009 are taxed in the following manner:

  • The amount of money paid in insurance premiums becomes the cost basis. Therefore life settlement proceeds up to the amount already paid in premiums is free of any taxes on life settlements.
  • The difference between the amount of premiums paid and the cash surrender value is treated as ordinary income for life settlement taxation purposes.
  • Taxes on life settlements for the amount above the cash surrender value are as capital gains.

Life settlement taxation of transactions completed on or after August 26, 2009 are taxed in the following manner:

Term Policies:
The aggregate amount of premiums paid above the cost of insurance or amount required to keep the policy in force are considered the basis and are tax free. Amounts above the basis will have life settlement taxation as capital gains.

Whole life or Universal Life Policies:

Life settlement taxation of Universal and Whole Life policies addresses the more complex nature of these policies.

  • The amount paid in insurance premiums above the cost required to keep the policy in force (cost of insurance) has no life settlement taxation or in other words is treated as tax-free.
  • The amount that is represented by “inside build up” on the policy (i.e., cash surrender value less aggregate premiums paid) is treated as ordinary income for the purposes of life settlement taxes.
  • Taxes on life settlement proceeds above the cash surrender value will be taxed as capital gains.

Please keep in mind that Amrita Financial does not provide life settlement taxation or tax advice. The above guidelines are from the Internal Revenue Service and do not address state life settlement taxation issues. If you have any questions regarding life settlement taxation please consult your tax professional. Please click on the following link to read the Internal Revenue Service bulletin regarding life settlement taxation and life settlement taxes.