The benefits of selling your life insurance policy for cash are clear, but do you know the tax consequences?
No one likes paying taxes. Fortunately, we have good news. The recently enacted tax law, the Tax Cuts and Job Act of 2017 (TCJA), contains two provisions that retroactively simplify and improve the tax treatment of life settlements.
First, the TCJA increases the estate tax exemption. In 2019, the estate tax exemption is $11,400,000 per person (increased from $11,180,000 in 2018 and $5,490,000 in 2017) or $22,800,000 per married couple. This higher estate tax exemption should make some policies that were purchased for estate tax purposes unnecessary.
Second, the TCJA revamps how the IRS taxes the cash you receive from the sale of your policy. Prior to enactment of the TCJA, the taxation of life settlements to policy sellers was complicated and difficult to follow in practice. Under Revenue Ruling 2009-13, published by the IRS in 2009, a policy seller was forced to reduce the basis in his or her policy by the cumulative cost of insurance charges assessed by the insurance carrier against the policy, resulting in more taxable gains. This also required sellers to know their cumulative cost of insurance charges, an amount that some life insurance companies didn’t provide.
The TCJA overruled Revenue Ruling 2009-13. Now, when you sell your policy for cash in a life settlement transaction, you are not required to reduce the policy’s basis by the cumulative cost of insurance charges. The higher basis results in lower taxable gains and puts policy sellers on an equal tax footing with people who choose to surrender their policies to the insurance carriers.
Life settlement proceeds are generally taxed as follows:
- Tax Free – Proceeds you receive up to your tax basis (i.e., the total amount of premiums you paid over time) are not taxable;
- Ordinary Income – Proceeds you receive in excess of your tax basis up to the amount of your policy’s cash surrender value are taxed as ordinary income; and
- Capital Gains – Remaining proceeds are taxed as capital gains.
In two specific circumstances, often referred to as a viatical settlement, meaning the sale of a life insurance policy by someone who is chronically or terminally ill, cash from selling your policy can be received entirely free from income tax.
If a life insurance policy on the life of an insured who is a “chronically ill individual” or a “terminally ill individual” is sold to a licensed life settlement provider, the sale price is treated as an amount paid under the policy by reason of the death of the insured. In other words, if you sell a policy on the life of an insured who meets the definition of a chronically ill individual or terminally ill individual, then the sale proceeds will be taxed as if the life insurance company had paid the death benefit. And, in most cases, death benefits are received free from income tax.
The Code defines a “terminally ill individual” as an individual who has been certified by a physician as having an illness or physical condition which can reasonably be expected to result in death in 24 months or less after the date of the certification. A “chronically ill individual” means a person who has been certified by a licensed health care practitioner as (i) being unable to perform (without substantial assistance from another individual) at least 2 activities of daily living for a period of at least 90 days due to a loss of functional capacity, or (ii) having a level of disability similar to the level of disability described in clause (i), or (iii) requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment. Activities of daily living include things like eating, bathing, dressing and toileting.
If you are interested in exploring whether your life insurance policy qualifies for a life settlement, Coventry Direct can help you. Just complete our online qualifier or call 1.800.COVENTRY or 1.800.268.3687 to speak with a Coventry Direct representative.
Coventry Direct does not offer tax or legal advice. This material has been prepared for informational purposes only and should not be relied upon for tax or legal advice. Coventry Direct urges you to consult with your own tax or legal advisors before entering into any transaction.