TCJA returned the tax treatment of a life settlement to what it had been widely believed to be prior to a 2009 ruling. A policyholder who sells a policy in a life settlement is generally taxed in three tiers as follows:
- Amounts received up to the tax basis are received free of income tax,
- Amounts received in excess of the tax basis up to the amount of the cash surrender value are taxed at ordinary income rates, and
- Amounts received in excess of the cash value get favorable capital gains treatment.
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so it would not matter whther you sell to the insurane company or a 3rd party. simply put you are lppoking for the most cash.. ehat the company offfers will probably differ differ froma LSC which may differ from each other. Life settlement companies may have restricions on what policies they will buy. here's one example
- The insured must have health conditions that limit life expectancy to under 20 years.
- If the insured is under age 65, life-threatening health conditions or a terminal diagnosis would be required.
- If the insured is age 65-74, serious health impairments would be needed in order to qualify.
- If the insured is age 75-79, chronic health conditions would likely be needed in order to qualify.
- If the insured is age 80+, qualification is likely but would depend on the future premium costs of the policy
- minimum policy value $100,000.
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The Health Status of the Insured. IRS rules
One of the first questions that should be addressed about taxation of life settlement proceeds is the health status of the insured who’s selling the policy.
If the insured is terminally ill, which means they have a life expectancy of fewer than two years, the settlement proceeds will be tax-free.
Technically, the transaction will be called a viatical settlement if the insured is terminally ill, and this has a different tax treatment from a life settlement transaction.
The IRS defines a terminally ill person as “someone who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death in 24 months or less after the certification date.”
In addition, if the insured is chronically ill, the settlement proceeds may not be taxed.
The IRS defines a chronically ill individual as “someone who has been certified (at least annually) by a licensed health care practitioner as being unable to perform, without substantial assistance from another individual, at least two daily living activities (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity.”
Or a person “requiring substantial supervision to protect the individual from threats to health and safety due to severe cognitive impairment.”
The settlement proceeds will not be taxed if the insured is terminally ill or chronically ill by IRS standards.
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any capital gains can be used to offset capital losses from other sources.
