Are Life Settlements Taxable?
The short answer to this question is yes, but the tax burden has been more advantageous to policyholders since 2017. The Tax Cuts and Job Act of 2017 (TCJA) provides more favorable tax treatment for life settlement sellers. The article below dives into the differences between the 2009-13 IRS Revenue Ruling and the new TCJA regulations.
2009-13 IRS Ruling
Prior to 2017, the IRS differentiated between policies surrendered to the insurer and policies being sold in a life settlement transaction.
– For policies being surrendered, the tax basis was their cumulative investment in the contract, which can be calculated by the amount of premiums paid minus withdrawals and dividends.
– For life settlements, the tax basis was reduced by the cumulative cost of insurance assessed against the policy. The issue was clearly two-fold:
- This was putting policyholders at a disadvantage if they were to choose a life settlement over a policy cash surrender. The tax basis defines the difference between what is and what is not taxable at either income tax or capital gains levels.
- The other problem with calculating the “cost of insurance” is that many insurance companies were not able to provide detailed records of those costs in a swift and efficient manner. For the sake of simplicity, many policyholders would opt for surrendering their policy, leaving a lot of money on the table.
Tax Cuts and Job Acts of 2017
The TCJA simplified the process, which gave a boost to the life settlement industry. More precisely, a life settlement is taxed in three different tiers:
- Tax-free for amounts obtained up to the tax basis.
- Ordinary income tax rates for amounts obtained between the tax basis and the cash surrender value.
- Capital gain tax rates for amounts obtained in excess of the cash surrender value.
Additionally, the law doubled the estate tax exemption, adjusted for inflation. Therefore, you may need to consult with a tax professional if your life insurance policy was purchased for estate tax purposes.
Life Settlement Taxation Case Study
$500,000 Life Settlement
Life Settlement Offer: $500,000
Cash Value: $375,000
Cost Basis: $225,000
Tax-free: $225,000 ($0 up to cost basis)
Taxable (Income Tax): $150,000 (Cash Value minus Cost Basis)
Taxable (Corporate Gains): $125,000 (Settlement minus Cash Value)
Life settlement taxes can be confusing, but the recent changes made by the TCJA help seniors tremendously.
For matters like these it is important to consult with an experienced life settlement broker. At Cedar Life Settlements, we are committed to providing our customers with the most up-to-date information.
If you are interested in knowing what your life insurance policy is worth, you can answer a few questions and receive your estimate immediately.
Disclaimer: Cedar Life Settlements does not provide tax nor legal advice. You may need to consult a tax professional.
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