If a client sold a life insurance policy last year, they are going to walk in with a Form 1099-LS, possibly a Form 1099-SB, and no idea what either one is. The reporting regime under IRC Section 6050Y reaches the buyer, the issuer, and the seller, so the forms circulate whether or not anyone explained them at closing.
The good news for basis computation is that the rules improved. Revenue Ruling 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change eliminating the cost-of-insurance basis reduction, so a seller’s basis is generally total premiums paid — materially better than the treatment under Revenue Ruling 2009-13. On the state side, Arizona applies a flat individual income tax rate as of 2026 and conforms to the Internal Revenue Code as of a specified date; verify both the current rate and the conformity date before finalizing a return.
Send us a redacted policy cover page. If a client is considering a sale rather than reporting one, that one page starts a free review with a typical one-to-two business day turnaround and no obligation. Call (305) 209-7183.
In This Article
The Three-Layer Gain Calculation
Work it in order and it stays simple. Start with total premiums paid, which under Revenue Ruling 2020-05 is generally the seller’s basis without reduction for cost-of-insurance charges. Compare that to the cash surrender value. The excess of cash surrender value over basis is generally ordinary income — the inside build-up the policy accumulated.
Then compare the sale price to the cash surrender value. The excess of sale proceeds over cash surrender value is generally capital gain, with holding period determining short or long term. If the sale price is below basis, the loss question is separate and unfavorable in the personal-use context; that analysis is worth running before assuming a deduction exists.
What the 6050Y Forms Actually Report
Form 1099-LS reports the payment made in a reportable policy sale, furnished by the acquirer to the seller and to the issuer. Form 1099-SB is the issuer’s statement, reporting the seller’s investment in the contract and the surrender amount — the two figures that drive the ordinary-versus-capital split above.
The 1099-SB is the more useful document because it is the carrier’s own statement of investment in the contract. When it conflicts with the client’s premium records, that discrepancy has to be reconciled before the return is filed rather than after a notice arrives. Clients frequently have better premium documentation than the carrier does, particularly on policies transferred between agents or acquired through carrier consolidation.
When Proceeds Are Not Taxable at All
IRC Section 101(g) provides that amounts received by a terminally ill insured are generally treated as an amount paid by reason of the death of the insured, and therefore excluded from gross income, when the certification requirements are met — ordinarily a physician’s certification of a life expectancy of 24 months or less. Chronically ill insureds have a separate, narrower rule tied to the use of proceeds and to per-diem limitations.
The practical CPA point is that the label on the transaction determines the treatment. A viatical settlement by a terminally ill client and a life settlement by a healthy 76-year-old are the same mechanical transaction with completely different outcomes. Get the certification documentation into the file at the time of the sale, not two years later when the return is under examination.
| Layer | Amount | General character |
|---|---|---|
| Basis | Total premiums paid, no cost-of-insurance reduction | Return of capital, not taxable |
| Cash surrender value over basis | Inside build-up recognized on sale | Ordinary income |
| Sale price over cash surrender value | The secondary-market premium | Capital gain, holding period applies |
| Terminally ill seller | Full proceeds, subject to certification | Generally excluded under IRC Sec. 101(g) |
| Reporting to the seller | Form 1099-LS from the acquirer | Payment in a reportable policy sale |
| Reporting from the issuer | Form 1099-SB | Investment in the contract and surrender amount |
Arizona State-Level Considerations
Arizona applies a flat individual income tax rate as of 2026, which removes most of the bracket-management complexity that drives timing decisions in graduated-rate states — verify the current rate before modeling. Arizona also conforms to the Internal Revenue Code as of a specified conformity date set by the Legislature, so check whether the relevant federal provisions are picked up for the year at issue.
Arizona is a community property state, which affects both the ownership analysis and the reporting where spouses file separately. Where a policy was acquired during the marriage with community funds, characterization of proceeds should be settled before the sale rather than reconstructed at filing time. See Arizona life settlement tax treatment for the broader framework.
The Advisory Conversation Before the Sale
CPAs frequently see the transaction first, because clients ask their accountant about a surrender before they ask anyone else. That is the moment where the comparison is worth putting in writing: the carrier’s cash surrender value, whatever the secondary market indicates, and the after-tax result of each.
Market-wide, offers are commonly quoted at roughly 10% to 35% of face value, and the GAO’s 2010 study (GAO-10-775) found settlement proceeds averaging several times cash surrender value. Because the ordinary-income layer is capped at the cash surrender value spread, a higher sale price generally adds capital gain rather than ordinary income — which means the after-tax comparison often favors the sale by more than the gross numbers suggest. Confirm on the specific facts.
Long-Term Care Clients and Timing
For clients heading toward Arizona long-term care Medicaid, the tax year of the sale is not the only timing question. The Arizona Long Term Care System applies a $2,000 individual countable-asset limit as of 2026, requires a separate Preadmission Screening functional assessment alongside financial eligibility, and delivers services through managed care program contractors.
Proceeds are countable in the month received, so the client’s elder law counsel needs the closing date as much as you do. Coordinating the sale date, the spend-down deployment, and the tax year together avoids the outcome where a client pays tax on a gain in one year and is ineligible for benefits in the next. See Arizona Medicaid asset and income limits.
How a Referral Works
If a client is weighing a surrender, you send one document with their permission: the policy cover page. It shows carrier, product type, face amount, and issue date — enough for a preliminary read on whether the contract has secondary-market value. No fee, no engagement, no obligation for you or the client.
The initial read is typically one to two business days. An indicative range requires a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization. A standard file from there runs roughly 60 to 120 days, which is worth knowing when a client wants the transaction in a particular tax year.
Your client stays in control throughout and can stop before closing. Call (305) 209-7183. Pine Lake works with policies of $100,000 or more in death benefit and typically produces more than cash surrender value.
This page is educational only and is not legal, tax, or investment advice for you or your client. Independent tax and legal counsel should review any transaction before it is executed.
Frequently Asked Questions
What is a client’s basis in a sold policy?
Generally total premiums paid. Revenue Ruling 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change removing the cost-of-insurance basis reduction that applied under Revenue Ruling 2009-13. Reconcile the client’s premium records against the Form 1099-SB figure.
Which forms will the client receive?
Form 1099-LS from the acquirer, reporting the payment in a reportable policy sale, and generally Form 1099-SB from the issuer, reporting the seller’s investment in the contract and the surrender amount. IRC Section 6050Y reaches the buyer, the issuer, and the seller.
How is the gain split between ordinary income and capital gain?
Generally, the excess of cash surrender value over basis is ordinary income, and the excess of sale proceeds over cash surrender value is capital gain. Because the ordinary layer is capped at that spread, a higher sale price usually adds capital gain rather than ordinary income.
When are proceeds excluded from income entirely?
Under IRC Section 101(g), proceeds received by a terminally ill insured are generally excluded when the certification requirements are met, ordinarily a physician certification of 24 months or less. Chronically ill insureds fall under a separate and narrower rule.
How does Arizona tax the gain?
Arizona applies a flat individual income tax rate as of 2026 and conforms to the Internal Revenue Code as of a legislatively specified conformity date. Verify both the current rate and the conformity date for the year at issue before finalizing the return.
Does Arizona community property law affect reporting?
It can, particularly where spouses file separately or the policy was acquired during the marriage with community funds. Characterization of ownership and proceeds should be settled before the sale rather than reconstructed at filing time.
Can a client deduct a loss on a policy sale?
The analysis is unfavorable in the personal-use context and should not be assumed. Run it on the specific facts before advising, and document the conclusion in the file.
What if the client has not sold yet?
Then the useful step is a written comparison of the carrier’s cash surrender value, a market indication, and the after-tax result of each. Send the policy cover page with the client’s permission for a free read, typically returned within one to two business days.
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Related Reading
- Life Settlement Taxes Arizona
- Cash Surrender Value Life Insurance
- Life Settlement Vs Surrender
- What Policies Qualify For Life Settlement
- Arizona Medicaid Asset Income Limits
- Education Center
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.