When a client sells a life insurance policy, the single most common preparer error is still reducing basis by the cost of insurance — a rule Congress killed in 2017 and that is retroactive to transactions after August 25, 2009. If your firm’s carryforward worksheet or your tax software’s insurance module was built before the Tax Cuts and Jobs Act, it may still be running the old arithmetic from Revenue Ruling 2009-13, and the result is a client who reports too much gain and overpays.
That is the headline issue, but it is not the only one. A life settlement produces information returns most preparers see once every few years, splits into three separate character buckets on one transaction, and can convert a tax-free death benefit into a taxable one for somebody else entirely. For an Alaska practitioner there is also a favorable wrinkle that changes the planning conversation: Alaska imposes no individual income tax and no estate or inheritance tax, so the federal treatment is the whole treatment.
This guide is written for the CPA, EA, or tax attorney whose client is contemplating a sale, has already closed one, or has walked in with a 1099-LS nobody in the office recognizes. It covers the mechanics, the Alaska regulatory frame, and the questions worth asking before the client signs anything.
In This Article
- When this lands on your desk in an Alaska practice
- The basis rule your software may still get wrong
- Three tiers, one transaction
- Forms 1099-LS and 1099-SB, and who sends what
- Transfer for value, and the exception that no longer works
- Alaska’s own tax posture, and why it simplifies the file
- Who regulates the transaction in Alaska, and the referral-fee line
- Alaska Medicaid, and what to tell the client to gather
- Frequently Asked Questions
When this lands on your desk in an Alaska practice
Three patterns account for most of the life settlement work that reaches a tax professional. The first is retrospective: an information return shows up in a client’s document packet in February, the client does not remember what it is, and the preparer has to reconstruct a transaction that closed nine months earlier without the closing statement. The second is a premium crisis — a retired client brings in a universal life policy whose internal charges have outrun the funding plan and asks whether to surrender it, and you are being asked, indirectly, whether there is a better exit. The third is long-term care funding, and in Alaska that one carries unusual weight.
Alaska has the highest institutional care costs in the United States. Recent published cost-of-care surveys have put the median semi-private nursing facility rate in Alaska well above $30,000 per month, which annualizes to a figure that exceeds most clients’ entire retirement portfolio inside four years. The state’s Pioneer Homes system, run by the Alaska Department of Health, is a distinctive piece of the landscape and operates on its own payment tiers, but it does not change the underlying arithmetic. When a family in Anchorage or Fairbanks starts pricing care, every asset on the balance sheet gets looked at, and an in-force policy with a large face amount and a small cash value is often the most misunderstood line on that sheet.
Your role is not to sell anything. It is to make sure that when the family evaluates the option, the after-tax number in the analysis is the right one, and that nobody has assumed the surrender value is the ceiling. A general explanation of the transaction itself is on our page on what a life settlement is.
The basis rule your software may still get wrong
Before 2017, the IRS position in Revenue Ruling 2009-13 was that a seller’s adjusted basis in a life insurance contract had to be reduced by the cumulative cost-of-insurance charges the policy had absorbed. On a policy held thirty years, that reduction could be enormous, and it inflated reported gain accordingly. Notably, the companion ruling for surrenders did not require the same reduction, which produced the odd result that selling a policy generated more taxable income than surrendering the identical contract.
Section 13521 of the Tax Cuts and Jobs Act (P.L. 115-97) amended IRC section 1016(a)(1)(B) to eliminate that adjustment. Basis is no longer reduced by mortality charges or cost-of-insurance charges. The change applies retroactively to transactions entered into after August 25, 2009, which means that if you are amending an older return for another reason, the settlement reported on it may itself be wrong in the client’s favor.
So the working definition of adjusted basis is straightforward: total premiums paid, reduced by any dividends received in cash, partial withdrawals, and untaxed distributions. It is not reduced by cost of insurance. It is not the cash surrender value. If the client cannot produce a premium history, the carrier can — request it in writing before you compute anything, because reconstructing thirty years of premiums from bank records is a losing exercise and an estimate on this line is an audit invitation.
One further point that trips people up: an outstanding policy loan does not disappear at closing. It is repaid out of the gross proceeds, but the full gross amount is the amount realized. A client who receives $180,000 of net cash on a $240,000 sale with a $60,000 loan has realized $240,000, not $180,000.
Three tiers, one transaction
The proceeds of a life settlement are split into three character buckets, and the return has to reflect all three. The mechanics are the same everywhere, but getting the ordering right matters because the middle tier is the one preparers miss.
- Tier one — return of capital. Proceeds up to the client’s adjusted basis are recovered tax-free. Nothing is reported as income.
- Tier two — ordinary income. The amount by which the policy’s cash surrender value exceeds adjusted basis is ordinary income. This is the inside build-up the client would have recognized on a surrender, and it does not change character just because the exit route changed.
- Tier three — capital gain. Anything the buyer paid above the cash surrender value is capital gain, long-term if the contract was held more than one year, reported on Form 8949 and Schedule D.
A worked example makes the ordering concrete. Assume a client paid $150,000 of premiums over the life of a universal life contract, the policy’s cash surrender value at closing is $190,000, and the settlement paid $420,000. Basis is $150,000, so $150,000 comes back tax-free. The spread between cash value and basis is $40,000 of ordinary income. The remaining $230,000 is long-term capital gain. Compare that to a surrender, which would have produced $190,000 total with $40,000 of ordinary income and no capital gain component at all.
Where the policy is a term contract with no cash surrender value, tier two is zero and the split is simply basis recovery and capital gain. Where the insured is terminally or chronically ill, the analysis changes entirely — see the section below on the section 101(g) exclusion.
Forms 1099-LS and 1099-SB, and who sends what
Section 13520 of the TCJA added IRC section 6050Y, which created a reporting regime specifically for what the statute calls a reportable policy sale. Final regulations were issued in 2019 (T.D. 9879) and apply to reportable policy sales occurring after December 31, 2018. Two forms result, and they come from two different parties, which is why clients rarely have both.
Form 1099-LS, Reportable Life Insurance Sale, is filed by the acquirer — the buyer of the policy — and furnished to the seller and to the issuing carrier. It reports the gross amount paid. Form 1099-SB, Seller’s Investment in Life Insurance Contract, is filed by the issuer, meaning the insurance company, and furnished to the seller. It reports the seller’s investment in the contract and the policy’s surrender amount.
In practice, the 1099-SB is the more useful document, because it is the carrier’s own statement of the two numbers you need for tier one and tier two. It is also the one clients routinely lose, because it arrives in a plain envelope from the insurance company months after the money landed. If it is missing, request a duplicate from the carrier’s policy service department rather than estimating.
Be aware that the carrier’s stated investment in the contract is computed under the carrier’s records and does not always match the taxpayer’s actual premium history, particularly where a policy was transferred, exchanged under section 1035, or serviced by multiple entities after a block acquisition. Where the two disagree, document the reconciliation in the file. The interaction between a 1035 exchange and a sale is covered separately on our page comparing a 1035 exchange with a settlement.
| Item | Federal treatment | Alaska treatment |
|---|---|---|
| Return of capital up to adjusted basis | Not taxable | No Alaska individual income tax |
| Cash value in excess of basis | Ordinary income | No state layer |
| Proceeds above cash surrender value | Long-term capital gain, Form 8949 / Schedule D | No state layer |
| Cost-of-insurance basis reduction | Repealed by TCJA sec. 13521, retroactive to 8/25/2009 | Follows federal |
| Terminally or chronically ill insured | Generally excluded under IRC sec. 101(g) | No state layer |
| Net investment income tax on the gain tier | 3.8% above sec. 1411 MAGI thresholds | Not affected by state law |
| Estate tax exposure on the death benefit | $15M federal exclusion for 2026, indexed | No Alaska estate or inheritance tax |
| Transaction regulator | State insurance regulators, not the IRS | Alaska Division of Insurance, AS 21.96.110 |
Transfer for value, and the exception that no longer works
IRC section 101(a) excludes life insurance death benefits from gross income. Section 101(a)(2) removes that exclusion when a policy has been transferred for valuable consideration: in that case the buyer includes the death benefit in income to the extent it exceeds the consideration paid plus premiums the buyer subsequently paid. The classic exceptions preserve the exclusion for a carryover-basis transfer and for transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer.
TCJA section 13522 added section 101(a)(3), which provides that those exceptions do not apply to a reportable policy sale. The practical effect is that an institutional buyer in a settlement transaction cannot claim a partnership or corporate exception to shelter the death benefit. That is the buyer’s problem, not your client’s, and it is priced into the market.
Where it becomes your client’s problem is in intra-family and business planning that runs parallel to a settlement conversation. A client who is thinking about selling a policy to a family LLC, a buy-sell partner, or a trust for consideration is walking straight into section 101(a)(2), and the exception analysis is fact-specific enough that it belongs in a written memo rather than a phone call. Trust-owned policies add another layer; the general contours are on our page about selling an ILIT or trust-owned policy.
Separately, IRC section 101(g) treats amounts received on the sale or assignment of a policy to a licensed viatical settlement provider as paid by reason of death, and therefore excluded from income, where the insured is terminally ill — certified by a physician as reasonably expected to die within 24 months — or chronically ill under section 7702B(c)(2). For a terminally ill Alaska client, that exclusion can turn a fully taxable transaction into a tax-free one, and the difference in after-tax proceeds is often larger than the difference between competing bids.
Alaska’s own tax posture, and why it simplifies the file
Alaska is one of the more favorable states in the country for this transaction, and the reason is subtraction rather than addition. Alaska imposes no individual income tax, so there is no state-level layer on the ordinary income tier or the capital gain tier. The federal computation is the entire computation, and there is no state return to prepare for the settlement, no state basis schedule to maintain, and no state capital gains preference to model.
Alaska also imposes neither an estate tax nor an inheritance tax. At the federal level, the exclusion amount was set at $15 million per decedent for 2026 under the 2025 federal legislation, indexed thereafter — confirm the current indexed figure before relying on it in a projection, because these amounts move. For the overwhelming majority of Alaska clients, that means the death benefit was never going to face transfer tax, which removes the most common argument for keeping an unwanted policy in force.
What Alaska does have is the Permanent Fund Dividend, and it matters here in an indirect way that is easy to overlook. The PFD is federally taxable, and a client who receives a large settlement in the same year can find that the combination pushes them across a bracket threshold, an IRMAA cliff for Medicare Part B and Part D premiums, or the net investment income tax threshold. Since the capital gain tier of a settlement is investment income, the 3.8% NIIT under section 1411 applies above the statutory MAGI thresholds. Where a client has discretion over closing timing — and in a competitive bid process there is often a few weeks of flexibility — a December closing versus a January closing can be worth real money. That is a legitimate planning conversation and it belongs to you, not to the buyer. Our page on life settlement taxes in Alaska covers the same ground for the client-facing side.
Who regulates the transaction in Alaska, and the referral-fee line
The regulator is the Alaska Division of Insurance, part of the Department of Commerce, Community, and Economic Development. Viatical settlement transactions are addressed in the Alaska Insurance Code at AS 21.96.110, within Title 21, Chapter 96 of the Alaska Statutes. That section directs the director to regulate viatical settlement contracts for the protection of viators, insureds, and insurers; requires viatical settlement providers, representatives, and brokers to be licensed before acting with respect to a subject resident or located in Alaska; and requires that contract forms, viator and insured disclosure statements, and advertising materials be filed with and approved by the director.
Statutory numbering does get renumbered and amended, so if you are citing the provision in an engagement letter or a written opinion, pull the current text from the Alaska Statutes or confirm it directly with the Division of Insurance rather than relying on a secondary source. The Division also maintains the licensee lookup that will tell you whether a specific provider or broker is authorized in Alaska, which is a two-minute check worth doing before a client hands over medical authorizations. See our page on life settlement licensing in Alaska for the consumer-facing version.
On compensation: a CPA who accepts a referral fee, finder’s fee, or commission in connection with a client’s policy sale has created a problem on at least three fronts. The AICPA Code of Professional Conduct requires disclosure of commissions and referral fees to the client and prohibits commissions outright in connection with an attest client. Many state insurance codes derived from the NAIC model act separately prohibit paying a finder’s fee to accountants, attorneys, or physicians in connection with policies insuring terminally ill individuals. And independence is compromised the moment your compensation depends on the client choosing one exit over another. The defensible posture is to charge your normal hourly rate for the tax analysis and take nothing from anyone else.
Alaska Medicaid, and what to tell the client to gather
Long-term care Medicaid in Alaska is administered through the Division of Public Assistance within the Alaska Department of Health, and the resource rules follow the federal framework. The countable resource limit for a single institutionalized applicant is commonly applied at $2,000; the community spouse resource allowance sits between a federal minimum and maximum that are indexed annually (the 2025 range ran from $31,584 to $157,920). Confirm current-year figures with the Division rather than a prior-year memo. The look-back period for uncompensated transfers is 60 months.
Two rules govern the policy itself. Under the SSI resource regulations at 20 C.F.R. section 416.1230, the cash surrender value of life insurance is a countable resource, but it is excluded entirely if the total face value of all policies on that insured is $1,500 or less. Above that threshold, the whole cash value counts. Term insurance with no cash value is not a resource at all. The second rule is the one families get backwards: selling a policy at fair market value is not an uncompensated transfer and does not create a transfer penalty, but the cash proceeds become a countable resource in the month after receipt. A sale that solves a premium problem can create an eligibility problem if nobody plans the spend-down. Our page on nursing home Medicaid spend-down walks through that sequence.
If a client is weighing this, the document list is short: the policy cover page showing form number, issue date, face amount, and owner; the most recent annual statement or in-force illustration; the premium history from the carrier; and the loan balance if any. Pine Lake Life Solutions provides education and a free policy review at no cost and does not purchase policies. We do not provide legal, tax, or investment advice — that is your role, and the analysis above is meant to support it, not replace it. If you want a second read on whether a client’s contract is even likely to attract interest before you build a projection around it, the review is free and the number is (305) 209-7183.
Frequently Asked Questions
My client’s 1099-SB shows an investment in the contract that does not match our premium schedule. Which controls?
Neither automatically. The carrier computes investment in the contract from its own records, which can be incomplete where a policy was exchanged under section 1035, transferred, or absorbed in a block acquisition. The taxpayer’s actual premium history controls the return, but you should reconcile the difference in writing and keep the carrier statement in the file. If the carrier’s figure is wrong, request a corrected form before filing.
Does the repeal of the cost-of-insurance basis reduction let me amend an older return?
The TCJA change to section 1016(a)(1)(B) applies to transactions entered into after August 25, 2009, so a settlement reported before 2018 under the old Revenue Ruling 2009-13 approach may have overstated gain. Whether an amended return is still available depends on the section 6511 limitations period for that year, which normally closes three years after filing. Check the statute before promising a client a refund.
Is a viatical settlement for a terminally ill Alaska client really tax-free?
Under IRC section 101(g), amounts received on the sale or assignment of a policy to a licensed viatical settlement provider are treated as paid by reason of the insured’s death, and therefore excluded, where a physician certifies the insured is reasonably expected to die within 24 months. Chronically ill insureds get a narrower exclusion subject to a per diem limit. The provider must be licensed, so verify that first.
Can I charge my client a percentage of the settlement proceeds for handling the tax work?
A contingent fee tied to transaction proceeds creates an independence problem under the AICPA Code of Professional Conduct and, if it functions as a finder’s fee, may run into insurance code prohibitions on compensating accountants in connection with these transactions. The clean approach is your standard hourly or fixed fee for the analysis, disclosed in the engagement letter, with no compensation from any party to the sale.
Does an Alaska client owe any state tax on a life settlement?
Alaska imposes no individual income tax, so neither the ordinary income tier nor the capital gain tier carries a state layer. Alaska also has no estate or inheritance tax. The practical implication is that federal planning is the only planning: bracket management, the 3.8% net investment income tax, and Medicare IRMAA thresholds are what timing decisions turn on, not a state return.
How does an outstanding policy loan affect the computation?
The loan is repaid from gross proceeds at closing, but the amount realized is the gross settlement price, not the net wire the client receives. Failing to gross it up understates gain. The loan also reduces the net death benefit a buyer is acquiring, which is why heavily loaned policies draw lower bids. Get the exact payoff figure from the closing statement rather than the client’s recollection.
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Related Reading
- What Is A Life Settlement
- Life Settlement Taxes Alaska
- Life Settlement Licensing Alaska
- Alaska Insurance Department Consumer Help
- 1035 Exchange Vs Settlement
- Sell Ilit Trust Owned Policy
- Nursing Home Medicaid Spend Down
- Estate Planner Life Settlement Guide Alaska
- Financial Advisor Life Settlement Guide Alaska
Pine Lake Life Solutions does not purchase life insurance policies and does not provide legal, tax, or investment advice. Information provided is for educational purposes only. Eligibility for any option, including life settlements, is not guaranteed and depends on individual circumstances, policy terms, underwriting, and market conditions. Consult independent legal, tax, or financial professionals before making decisions regarding a life insurance policy.