Two things put a life settlement on a CPA’s desk: a recurring insurance premium showing up on a cash-flow review or a fiduciary return, and a pair of unfamiliar information returns — Forms 1099-LS and 1099-SB — arriving in a client’s tax packet after a sale has already closed. The first is an advisory opportunity. The second is a compliance question you need an answer to before the return goes out.
This page covers both, for Illinois practitioners: how basis is computed after Revenue Ruling 2020-05, how the two-tier gain split works, what IRC Section 6050Y requires of whom, how Illinois treats the gain, and what a client’s benefits picture looks like if long-term care Medicaid is anywhere on the horizon.
Pine Lake Life Solutions provides education and free policy reviews only. Nothing here is tax, legal, or investment advice, and none of it replaces your own analysis of a client’s facts. Questions: (305) 209-7183.
In This Article
Why the CPA Sees It First
The accountant is frequently the only professional looking at every recurring outflow in a client’s life. An $11,000 annual universal life premium on a policy nobody has discussed in a decade is visible on a cash-flow schedule, on a trust’s fiduciary return as an administration expense funded by distributions, or on a business return as an outdated key-person or buy-sell premium the entity kept paying after the arrangement dissolved.
When you spot one, the question worth asking the client is not whether they can afford it — it is whether the death benefit still buys anything they want. If the answer is no, there are more exits than lapse and surrender. A redacted policy cover page, sent with the client’s permission, gets a free read on whether the policy has secondary-market value, typically back in one to two business days with no obligation.
Basis After Revenue Ruling 2020-05
This is the change most worth knowing, because older memos in client files say something different. Under Revenue Ruling 2009-13, a seller’s basis in a life insurance contract was reduced by the cost-of-insurance charges absorbed over the life of the policy — which, on an old contract, could shrink basis dramatically and inflate the taxable gain.
The 2017 Tax Cuts and Jobs Act reversed that treatment for sales, and Revenue Ruling 2020-05 conformed IRS guidance to the statute. Under current treatment, the seller’s basis in the contract is generally total premiums paid, without reduction for cost-of-insurance charges. For a client who has carried a policy for twenty-five years, the difference between the two rules can be six figures of taxable gain. Confirm the current state of the guidance for 2026 before relying on it in a filed position, and document the premium history you used — carrier premium ledgers are the best available substantiation and are worth requesting early.
The Two-Tier Gain Split
The general federal framework for a sale by the policy owner runs in three layers:
- Return of basis. Proceeds up to total premiums paid are generally recovered tax-free.
- Ordinary income. The portion of gain up to the excess of cash surrender value over basis — the amount the client would have recognized on a straight surrender — is generally ordinary income.
- Capital gain. Proceeds above the cash surrender value are generally long-term capital gain where the contract has been held long enough.
Two documents make the computation possible: the carrier’s statement of cash surrender value as of the sale date, and a complete premium history. Get both before you model anything. Note also that an outstanding policy loan complicates the arithmetic — the loan is generally treated as an amount realized, which can produce taxable gain even where the client’s net cash at closing looks modest.
Separately, a viatical settlement is a different animal: where a physician certifies a life expectancy of 24 months or less and the statutory requirements are met, proceeds are generally excluded from income under IRC Section 101(g). Terminal-illness fact patterns should be analyzed under that provision rather than the sale rules above.
| Item | General Federal Treatment (2026) | Documentation to Pull |
|---|---|---|
| Basis in the contract | Generally total premiums paid; no reduction for cost of insurance (Rev. Rul. 2020-05) | Carrier premium history / ledger |
| Proceeds up to basis | Generally tax-free return of investment | Closing statement |
| Gain up to cash surrender value | Generally ordinary income | Carrier CSV statement as of sale date |
| Proceeds above cash surrender value | Generally long-term capital gain | Purchase agreement, holding period |
| Outstanding policy loan | Generally treated as amount realized | Loan balance and accrued interest at closing |
| Terminal illness (LE 24 months or less) | Generally excluded under IRC 101(g) if requirements met | Physician certification |
| Information reporting | Forms 1099-LS (acquirer) and 1099-SB (issuer) under IRC 6050Y | Both forms; reconcile 1099-SB basis to your computation |
| Illinois | Flat individual rate applied from federal AGI; no preferential capital gains rate (confirm 2026 rate) | Illinois Department of Revenue guidance |
IRC Section 6050Y: Who Files What
A sale of a life insurance contract to a buyer with no substantial family, business, or financial relationship with the insured is generally a reportable policy sale, and the information reporting regime under IRC Section 6050Y applies. In broad outline:
- Form 1099-LS is furnished by the acquirer to the seller and to the issuing carrier, reporting the amount paid.
- Form 1099-SB is furnished by the issuing carrier to the seller, reporting the seller’s investment in the contract and the surrender amount — the carrier’s own view of basis.
- Form 1099-R may also appear depending on the transaction.
Two practice points. First, the 1099-SB investment-in-contract figure is the carrier’s number and will not always match the premium history you compute; where they differ, reconcile and document rather than defaulting to the form. Second, warn the client that these forms will arrive so that they reach you instead of a drawer. Reporting obligations on a transfer to a foreign person and on subsequent transfers have their own rules; check the current regulations for those fact patterns.
Illinois State Treatment
Illinois is a flat-rate individual income tax state and begins its computation from federal adjusted gross income, so the federally recognized gain on a policy sale flows into the Illinois base without a separate state characterization of the ordinary and capital components — Illinois does not provide a preferential capital gains rate. As of 2026, confirm the current Illinois individual rate and any applicable subtraction modifications with the Illinois Department of Revenue before quoting a client an effective rate.
For trust and estate clients, the Illinois fiduciary return and the Illinois replacement tax add their own layer, and a trust-owned policy sale should be modeled at the entity level with an eye to whether gain is distributed or retained. Our overview of life settlement taxes in Illinois covers the framework in client-facing language.
When Medicaid Is in the Picture
If the client is heading toward long-term care Medicaid, the tax analysis is only half the problem. Illinois administers long-term care coverage through HealthChoice Illinois managed long term services and supports and, for home and community based services, the Community Care Program. Illinois raised its individual countable-asset limit from the traditional $2,000 to $17,500 in 2023 — one of the most generous thresholds in the country — and as of 2026 you should confirm the current figure and the community spouse resource allowance with the Illinois Department of Healthcare and Family Services.
Two federal mechanics matter for your modeling. Life insurance is generally disregarded only where total face value across all policies is $1,500 or less; above that, cash surrender value is a countable resource. And the 60-month look-back penalizes transfers for less than fair market value, which is exactly why a documented arm’s-length sale is used rather than a gift to a child. Illinois’s application processing backlog also means families often need private-pay bridge funding for months while a determination is pending — a cash-flow issue you will be asked to model. See Illinois Medicaid asset and income limits for the underlying rules, and route the eligibility planning itself to elder law counsel.
How a Referral Works
Minimal on your end and free for the client. With the client’s permission, send a redacted policy cover page — carrier, policy type, face amount, issue date, insured’s date of birth. That yields a free candidate assessment, typically in one to two business days, with no obligation for you or the client and no client contact unless your client requests it.
If the client wants an indicative range, four documents produce one: the cover page, a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization. The market profile is an insured roughly 70 or older, or any age with a material health change since issue; a death benefit of $100,000 or more; and a permanent, guaranteed universal life, whole life, or convertible term contract. A standard file runs roughly 60 to 120 days from submission to funding, held in independent escrow. Historically, market-wide, sellers have received on the order of 10% to 35% of face value — the federal Government Accountability Office study of the market (GAO-10-775) found settlements averaging roughly 4 to 8 times what surrender would have paid. No one can name a client’s number without the file.
Call (305) 209-7183. Background material for clients is in our Education Center.
Educational only. This page is not tax, legal, or investment advice and is not an offer to purchase any policy. Illinois transactions are governed by the Illinois Viatical Settlements Act, 215 ILCS 158, administered by the Illinois Department of Insurance.
Frequently Asked Questions
How is basis computed on a policy sale now?
Under Revenue Ruling 2020-05, which conformed IRS guidance to the 2017 Tax Cuts and Jobs Act, basis is generally total premiums paid and is no longer reduced by cost-of-insurance charges as Revenue Ruling 2009-13 required. On a long-held policy the difference can be substantial. Pull the carrier’s premium history as substantiation and confirm the current state of the guidance for 2026.
What is the split between ordinary income and capital gain?
Proceeds up to basis are generally a tax-free return of investment; gain up to the excess of cash surrender value over basis is generally ordinary income; proceeds above cash surrender value are generally long-term capital gain where the holding period is met. You need the carrier’s cash surrender value as of the sale date and a complete premium history to run it. An outstanding policy loan is generally treated as an amount realized and can create gain even when net cash looks small.
Who files Forms 1099-LS and 1099-SB?
Under IRC Section 6050Y, the acquirer generally furnishes Form 1099-LS to the seller and the issuing carrier, and the carrier generally furnishes Form 1099-SB to the seller reporting investment in the contract and the surrender amount. The client will receive forms and will ask what to do with them. Warn them in advance so the documents reach you rather than a file drawer.
The 1099-SB basis figure doesn’t match my computation. Now what?
The investment-in-contract number on the 1099-SB is the carrier’s figure and does not always reconcile to a premium history you have independently verified, particularly on old contracts with dividend elections, loans, or prior partial surrenders. Reconcile the difference, document the support for the position you take, and consider whether disclosure is appropriate. Do not simply default to the form.
Is a viatical settlement taxed the same way?
No. Where a physician certifies a life expectancy of 24 months or less and the statutory requirements are met, proceeds are generally excluded from income under IRC Section 101(g) rather than run through the sale framework. Terminal-illness fact patterns should be analyzed under that provision. Confirm the certification and the settlement provider’s status against the applicable requirements.
How does Illinois tax the gain?
Illinois computes individual tax at a flat rate starting from federal adjusted gross income and provides no preferential capital gains rate, so both the ordinary and capital components generally flow into the Illinois base at the same rate. As of 2026, confirm the current rate and any subtraction modifications with the Illinois Department of Revenue. Trust and estate clients also have the Illinois fiduciary return and replacement tax to consider.
Will a settlement disqualify a client from Medicaid?
Cash received is countable in the month of receipt, so timing and post-receipt planning matter. Illinois raised its individual countable-asset limit to $17,500 in 2023, considerably more forgiving than most states; as of 2026, confirm current figures with the Illinois Department of Healthcare and Family Services. A documented arm’s-length sale at fair market value is not a below-market transfer under the 60-month look-back, but eligibility planning belongs with elder law counsel.
What do you need from me to tell a client whether the policy is worth selling?
One redacted cover page, sent with the client’s permission — carrier, policy type, face amount, issue date, insured’s date of birth. The review is free, typically returns in one to two business days, and carries no obligation for you or the client. If the client wants an indicative range, add the in-force illustration, the latest carrier statement, and a signed HIPAA authorization.
Find out what your policy is worth — free, confidential, no obligation.
A 15-minute educational review covers your eligibility, every alternative, and a realistic view of what each path would net you.
Related Reading
- Life Settlement Vs Surrender
- Cash Surrender Value Life Insurance
- Education Center
- Life Settlement Taxes Illinois
- Illinois Medicaid Asset Income Limits
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.