Selling Life Insurance Policy Tax Consequences Explained

Selling a life insurance policy can have significant tax implications, and it's essential to understand the consequences to make informed decisions.

You'll be taxed on the gain from selling a life insurance policy, which is the difference between the sale price and the policy's cost basis.

The Internal Revenue Service (IRS) considers the gain from selling a life insurance policy as ordinary income, not capital gains.

The tax rate you'll pay on the gain depends on your tax bracket and the type of policy you're selling.

If you've held the policy for a short time, you may be subject to a higher tax rate on the gain.

Selling your life insurance policy can have significant tax implications. In two specific circumstances, often referred to as a viatical settlement, you can receive cash from selling your policy entirely free from income tax.

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. This means that in most cases, death benefits and accelerated death benefits are received free from income tax.

A terminally ill individual is defined 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 being unable to perform at least 2 activities of daily living for a period of at least 90 days due to a loss of functional capacity.

The tax rules for life settlements are complex, but generally, the amount you receive above and beyond your cash surrender value is taxed as capital gains.

Here's a breakdown of how life settlement proceeds are taxed:

For example, if you receive $100,000 in life settlement proceeds for a policy that you paid $30,000 in premiums toward and had a cash surrender value of $50,000, the first $30,000 of your proceeds would be considered your tax basis and would be tax-free. The next $20,000 would be taxed as ordinary income, and the remaining $50,000 would be taxed as capital gains.

A life settlement can result in either a capital gain or ordinary income, depending on the circumstances. Generally, if there's no cash surrender value, the gain is taxed as capital gain.

Any gain on sale can be taxed either as capital gain or ordinary income, depending on the circumstances. Generally, it is capital gain if there is no cash surrender value (in a whole or universal life policy for example).

Part of the income from a life settlement may be ordinary and part may be considered capital gain, especially when there is cash surrender value involved. Complex accounting exists in these cases.

The sale proceeds from a life settlement are generally taxable income, just like the sale of any other asset. You must include in income the difference between your cost of the policy and your sales price.

A term policy would normally have a zero cost basis, making the sales price the entire taxable amount. The cost of a whole life policy can be a complex calculation, best handled by an accountant.

In some cases, a taxpayer may be able to deduct a loss from the sale of a life insurance policy, but this is limited to cases where the loss was incurred in a trade or business.

The sale of a life insurance policy can have tax implications, but the good news is that some proceeds may be tax-free. Proceeds you receive up to your tax basis are not taxable.

However, if you sell your life insurance policy early, the sale proceeds are generally taxable income. The difference between your cost of the policy and your sales price must be included in income.

In some cases, the sale of a life insurance policy can be tax-free, even if you're not terminally ill. 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.

The IRS 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 being unable to perform at least 2 activities of daily living for a period of at least 90 days due to a loss of functional capacity.

Here's a breakdown of how tax consequences are applied:

Keep in mind that tax laws and regulations can change, so it's essential to consult with a professional accountant to ensure you're in compliance with current tax laws.

If you sell your life insurance policy for medical reasons, you might be able to avoid paying taxes on the proceeds.

There are specific requirements to meet this exception, so it's essential to consult a tax adviser in advance and keep thorough documentation of the evidence.

This exception falls into two categories, but the details are not specified in the provided article sections.

To qualify for tax-free treatment, you'll need to meet the requirements outlined by the IRS, but the specific details are not provided in the article sections.

If you're considering selling your policy for medical reasons, it's crucial to consult a tax professional to determine if you qualify for this exception and to ensure you're following the correct procedures.

The article sections don't provide a clear example of what qualifies as a medical reason for selling a policy, so it's essential to consult a tax expert for guidance.

You'll need to carefully review the IRS guidelines and consult with a tax adviser to determine if you meet the requirements for a nontaxable viatical settlement.

When selling a life insurance policy, it's essential to understand the tax consequences involved. According to the IRS Guidelines, if a term life insurance policy is sold, then 100% of the life settlement proceeds should be treated as a capital gain.

A term policy with a death benefit of $500,000 sold for a settlement amount of $70,000 will result in a tax liability of $55,000, which is the amount used to determine the total tax liability.

To calculate the tax liability, you need to subtract the cost basis from the settlement amount. If the result is a positive number, it's taxed at the long-term capital gain tax rate. In this example, the cost basis is $15,000, so the result is $55,000.

If the cash surrender value (CSV) is higher than the premiums paid, the tax calculation becomes more complex. For example, a universal life policy with a death benefit of $1,000,000 sold for a settlement amount of $90,000 will have a tax liability of $26,000. The CSV is $70,000, which is higher than the premiums paid of $64,000.

Here's a breakdown of the tax components:

People often buy life insurance for specific reasons, and when those reasons change, they may decide to sell their policy. A key-person insurance policy, for example, is no longer needed when a key person in a business retires.

Businesses may have a buy-sell agreement that involves a life insurance policy. If the business is sold, the buy-sell life insurance is no longer needed.

Here are some types of life insurance policies that may be sold:

Each type of policy has its own tax implications, and it's essential to understand these before making a decision.

Your tax basis in a life insurance policy is the total amount of premiums you paid for or into the contract, minus any tax-free withdrawals from the contract. This is a crucial factor in determining how your life settlement proceeds will be taxed.

The tax basis is calculated by subtracting tax-free withdrawals, such as dividends or other income tax-excluded withdrawals, from the total amount of premiums paid. This calculation will give you your investment in the life insurance contract.

For example, let's say you paid $30,000 in premiums toward your life insurance policy and received $10,000 in tax-free dividends. Your tax basis would be $30,000 - $10,000 = $20,000.

Here's a breakdown of how your life settlement proceeds will be taxed based on your tax basis and investment in the contract:

As you can see, the amount of your life settlement proceeds that are taxed as ordinary income is based on the difference between the cash surrender value and your tax basis. The amount above the cash surrender value is taxed as capital gains.