The CPA is usually the first professional to see a policy heading for lapse, because the premium shows up as a recurring outflow long before anyone calls it a planning problem. It appears on a retiree’s cash-flow review, on a trust’s fiduciary return as an ongoing distribution, or as the line item a client asks about while wondering what to cut.
The tax answer is better than most practitioners remember. Rev. Rul. 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change: a seller’s basis is no longer reduced by cost-of-insurance charges, so basis is generally total premiums paid — a material improvement over the older Rev. Rul. 2009-13 treatment. Reporting runs through IRC Section 6050Y, which puts Forms 1099-LS and 1099-SB in front of your client whether or not they warned you first.
Send a redacted policy cover page. With the client’s permission, one page gets a free initial read, typically inside one to two business days, with no obligation. Call (305) 209-7183.
In This Article
- Where the Policy Shows Up in Your Work
- Basis After Rev. Rul. 2020-05
- The Ordinary Income and Capital Gain Split
- Section 6050Y: The Forms Your Client Will Bring You
- Viatical Settlements Are a Different Return
- When the Client Is Also a Medicaid Planning Case
- How a Referral Works
- Frequently Asked Questions
Where the Policy Shows Up in Your Work
Four places, mostly. A personal cash-flow or retirement projection where a $7,000 annual premium is competing with living expenses. A Form 1041 for a trust that has been paying premium out of principal. A business return carrying an old key-person or buy-sell policy on a shareholder who exited years ago. And an estate or gift engagement where an ILIT’s purpose is obviously obsolete.
In each case the client’s mental model is binary — keep paying or stop paying. The third possibility, that the contract has a market value materially above its cash surrender value, is rarely on the table because nobody put it there. You do not have to recommend it. Raising it and routing the client to an independent valuation is enough.
Basis After Rev. Rul. 2020-05
Under Rev. Rul. 2009-13, a seller’s basis was reduced by the cost-of-insurance charges absorbed over the life of the contract, which on an old policy could be a very large reduction. The 2017 Tax Cuts and Jobs Act changed that for sales after August 25, 2009 in the relevant provision, and Rev. Rul. 2020-05 conformed the IRS position. The working rule now is that basis is generally aggregate premiums paid, without the cost-of-insurance haircut.
Practical consequence: a client who was previously told a sale would be mostly taxable may now have substantially less gain than the old analysis produced. If you are looking at a file where someone ran the numbers before 2020, the numbers are stale. Confirm the current rule and any 2026 developments before you put a figure in a memo.
The Ordinary Income and Capital Gain Split
The character analysis is a two-tier calculation. Gain up to the cash surrender value, to the extent it exceeds basis, is ordinary income — that is the inside build-up the client never paid tax on. Gain above the cash surrender value is generally capital gain, long-term where the holding period supports it. Amounts up to basis are a tax-free return of investment.
Outstanding policy loans complicate this, because a loan discharged at sale is treated as amount realized, and a client who believes they are receiving a modest net check can be surprised by the taxable number attached to it. Pull the carrier statement and look at the loan balance before you estimate anything. Our overview at Indiana life settlement taxes walks the same framework in plain language for clients.
| Layer of proceeds | Tax character | Authority / note |
|---|---|---|
| Amount up to basis | Tax-free return of investment | Basis generally equals total premiums paid, per Rev. Rul. 2020-05 |
| Gain up to cash surrender value | Ordinary income | Represents untaxed inside build-up |
| Gain above cash surrender value | Generally capital gain | Long-term where the holding period supports it |
| Discharged policy loan | Included in amount realized | Check the carrier statement before estimating net proceeds |
| Viatical proceeds (terminal illness) | Generally excluded from income | IRC Sec. 101(g), with physician certification of life expectancy |
| Information reporting | Forms 1099-LS and 1099-SB | IRC Sec. 6050Y; reconcile the carrier’s stated investment in the contract |
Section 6050Y: The Forms Your Client Will Bring You
A reportable policy sale triggers information reporting under IRC Section 6050Y, and three parties have obligations. The buyer files Form 1099-LS reporting the payment to the seller and notifies the issuing carrier. The carrier files Form 1099-SB reporting the seller’s investment in the contract and the surrender amount. The seller receives copies and reports the transaction on the return.
Two practice notes. First, the 1099-SB’s stated investment in the contract is the carrier’s number, and it will not always match your basis computation — reconcile rather than adopt. Second, where the seller is a trust, the forms follow the trust and the transaction belongs on the fiduciary return, which is a conversation worth having with the trustee before year end rather than in March.
Viatical Settlements Are a Different Return
If the insured is terminally ill, the transaction may qualify as a viatical settlement rather than a life settlement, and proceeds are generally excluded from income under IRC Section 101(g) when a physician certifies a life expectancy within the statutory window — commonly framed as 24 months or less. Chronically ill certifications have their own rules and limitations.
That distinction changes the entire answer, so establish it before you model anything. It also changes the state overlay: Indiana Code Chapter 27-8-19.8 governs settlement contracts generally, with the Indiana Department of Insurance regulating providers and brokers. Indiana has no state-level income tax quirk that reverses the federal character analysis, but Indiana’s flat individual income tax and county-level income taxes still apply to whatever ends up in adjusted gross income — verify the 2026 rates before quoting them.
When the Client Is Also a Medicaid Planning Case
Where the client is heading toward long-term care, the tax analysis and the eligibility analysis run on different clocks. Long-term care Medicaid in Indiana runs through Indiana PathWays for Aging, the managed LTSS program launched in 2024, against a $2,000 individual countable-resource limit as of 2026. Cash surrender value above the small-face-value disregard is a countable resource; commonly cited as $1,500 of total face value across states, though you should confirm Indiana’s current treatment with FSSA.
The point for the CPA is timing. Proceeds are income for tax purposes in the year received and a countable resource for eligibility purposes in the month received, and the two consequences do not cancel each other. Coordinate with the client’s elder law counsel on sequencing rather than letting the sale close in a month that wrecks an application.
How a Referral Works
With the client’s permission, you send only the policy cover page — carrier, product type, face amount, issue date. That is enough for an initial read, typically returned in one to two business days. There is no fee and no obligation for you or the client.
If the policy looks viable, an indicative range requires three more documents: 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 through funding, which is why a December sale is usually a January or February decision.
The client remains in control throughout, can stop before closing, and can have you review the tax consequences of any offer before it is accepted. Call (305) 209-7183 or send the cover page for a free policy review.
This page is educational only and is not legal, tax, or investment advice for you or your client. Pine Lake Life Solutions does not provide legal or tax counsel; independent counsel should review any transaction before it is signed.
Frequently Asked Questions
What is my client’s basis in a sold life insurance policy?
Generally total premiums paid. Rev. Rul. 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change, so basis is no longer reduced by cost-of-insurance charges as it was under Rev. Rul. 2009-13. Any analysis run before 2020 should be recomputed.
How is the gain characterized?
In two tiers. Gain up to the cash surrender value above basis is ordinary income, and gain above the cash surrender value is generally capital gain. Amounts up to basis are a tax-free return of investment.
What do Forms 1099-LS and 1099-SB tell me?
Form 1099-LS is filed by the buyer reporting the payment to the seller. Form 1099-SB is filed by the issuing carrier reporting the seller’s investment in the contract and the surrender amount. Both flow from IRC Section 6050Y reportable policy sale rules, and the carrier’s stated investment figure should be reconciled against your own basis computation.
Is a viatical settlement taxed differently?
Yes. Where the insured is terminally ill and a physician certifies a life expectancy within the statutory window, proceeds are generally excluded from income under IRC Section 101(g). Establish whether the transaction is viatical or a standard life settlement before modeling anything, because the answers are entirely different.
Does an outstanding policy loan change the calculation?
Substantially. A loan discharged at sale is treated as part of the amount realized, so a client receiving a small net check can still recognize significant gain. Pull the current carrier statement and confirm the loan balance before quoting any number.
How does Indiana tax the proceeds?
Indiana does not reverse the federal character analysis; whatever flows into adjusted gross income is subject to Indiana’s flat individual income tax plus the applicable county income tax. Verify the 2026 state and county rates before quoting them to a client.
How does this interact with Medicaid eligibility?
Proceeds are income for tax purposes in the year received and a countable resource for eligibility purposes in the month received. Long-term care Medicaid in Indiana runs through PathWays for Aging with a $2,000 individual countable-resource limit as of 2026, so coordinate closing timing with the client’s elder law counsel.
What does it cost the client to find out what a policy is worth?
Nothing. The review is free and carries no obligation. Send the policy cover page with the client’s permission for an initial read, generally within one to two business days; a full indicative range then requires the in-force illustration, latest carrier statement and a signed HIPAA authorization.
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Related Reading
- Life Settlement Taxes Indiana
- Cash Surrender Value Life Insurance
- Life Settlement Vs Surrender
- What Policies Qualify For Life Settlement
- Indiana 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.