Life Settlement Taxation: How it Works

You are thinking about a life settlement transaction. You were surprised to find out that your life insurance policy is worth significantly more than its surrender value.

Before you pull the trigger and take advantage of this hidden asset you need to understand the tax consequences of selling your life insurance. We’re here to help.

Good news- the tax consequences of selling your life insurance have become simpler with the new Tax Cuts and Job Act of 2017 (TCJA).

Life Settlement Taxation Forms

How are life settlements taxed?

When you sell your policy you will be taxed in three tiers:

  1. Proceeds received up to the tax basis are free of income tax.
  2. Proceeds received that are greater than the tax basis up to the amount of the cash surrender value are taxed at ordinary income rates.
  3. Proceeds received that are in excess of the cash value get taxed as capital gains.

So what does TCJA have to do with life settlement taxation?

The Tax Cuts and Jobs Act of 2017 makes figuring out your tax basis significantly easier. Previously, based on Revenue Ruling 2009-13, there was a different tax basis calculation for people selling their insurance policies and those surrendering.

For people surrendering their policies the tax basis was their cumulative investment in the contract. This is generally the premiums paid less any withdrawals and dividends.

For people selling their policies the IRS ruled that this basis needed to be further reduced by the cumulative cost of insurance. This meant that people selling their policies had to track down their cumulative cost of insurance – a number many insurance companies don’t even have on file.

More importantly, it meant that a smaller portion of the proceeds was tax free.

TCJA makes the basis calculation for both life settlements and surrenders the same. Those selling their policies no longer need to reduce the taxable basis by the cumulative cost of insurance.

Less work and more money. We love that here at Mason Finance.

Mason Finance does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

 

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