Life Settlements-What are your Tax Implications?

The tax scenario of life settlements has not been defined by legislation, but the arrangement has two tax elements that are deliniated by prior tax law scenarios.

The tax treatment of policy gains is no different from the tax treatment of cash surrender. In a policy surrender, the difference between the premium payments (basis) and the interest accumulated (gains) is taxed as ordinary income. The same treatment applies for a Life Settlement arrangement on the piece differentiated by the gain minus the basis.

The best part for the seller of a Life Insurance Settlement policy involves selling the policy for a percentage of the face amount. Since life insurance, according to the tax code, is considered a capital investment, any amount paid by the institional funder above the cash surrender value is taxed as a capital gain.

To a policy sellers, a senior settlement typically engenders 3 types of tax:

Zero Taxation —up to the basis, since it is capital return.

Ordinary income—from the basis to the cash surrender threshold..

Capital gains—from either the cash surrender value or the basis, whichever is higher, to the settlement offer, since a life settlement agreement involves selling the contract, and the insurance contract is treated as a capital investment, this portion of the gain is treated as a capital gain.is a capital asset.

An Example:

Policy Face $5,000,000

Basis in policy $1,000,000

Surrender value $1,500,000

Settlement proceeds $3,000,000

Ordinary gain equals $500,000 (surrender value less basis)

Capital gain equals $1,500,000 (proceeds less surrender value)

$1,000,000 is received tax-free as a return of investment in policy

Another Example

Face amount $3,000,000

Basis in policy $1, 500,000

Surrender value $1,350,000

Settlement proceeds $2,400,000

Ordinary gain equals $0(surrender value less basis)

Capital gain equals $900,000 (proceeds less basis)

$1,500,000 is received tax-free as return of investment in policy

Please keep in mind that these are generic guidelines and should not be relied upon for your specific situation. Each situation is unique. Consult with a professional tax advisor prior to the transaction.

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