When a client sells a life insurance policy, Forms 1099-LS and 1099-SB show up in the mail and the client calls you — so the reporting regime is usually where a CPA meets this transaction, whether or not anyone consulted you beforehand. IRC Section 6050Y imposes information reporting obligations on the buyer, the issuer, and the seller in a reportable policy sale, which is why the forms proliferate.
The good news for the return is that basis got better. Rev. Rul. 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change, so a seller’s basis is no longer reduced by cost-of-insurance charges as it was under Rev. Rul. 2009-13. Basis is generally total premiums paid, which materially reduces reported gain compared with the old treatment.
Send a redacted policy cover page. With client permission, one page starts a free review before a transaction is structured — a much better sequence than reconstructing it at filing time. First read is typically one to two business days, no obligation. Call (305) 209-7183.
In This Article
The 6050Y Reporting Chain, Party by Party
Three parties, two forms. The acquirer in a reportable policy sale files Form 1099-LS reporting the payment to the seller, and also furnishes a statement to the issuer. The issuer, in turn, files Form 1099-SB reporting the seller’s investment in the contract and the surrender amount. The seller receives copies and uses them to compute gain.
The practical failure mode is a client who receives two unfamiliar forms months after a transaction they never mentioned, panics, and brings them in with no closing documents. Ask the question during the organizer process for any client over 70 with permanent coverage: did you sell, surrender, or lapse a life insurance policy this year?
Basis After Rev. Rul. 2020-05
Under Rev. Rul. 2009-13, a seller’s basis was reduced by the cost-of-insurance charges embedded in the premiums, which inflated reported gain and made the arithmetic dependent on carrier data that was often difficult to obtain. The 2017 Act reversed that treatment, and Rev. Rul. 2020-05 conformed the published guidance.
The working rule now is that basis is generally total premiums paid. That is a number a client can often reconstruct from their own records, and the issuer’s 1099-SB reports investment in the contract as a cross-check. Reconcile the two rather than accepting either in isolation, and document the reconciliation in the workpapers.
Two-Tier Gain Character
Gain splits at cash surrender value. Amounts received up to basis are a tax-free return of basis. Gain from basis up to the policy’s cash surrender value is ordinary income. Gain above cash surrender value is capital gain, with holding period determining short or long term.
That second tier is why the carrier’s cash surrender value as of the sale date is a required workpaper item, not an optional one. Without it there is no defensible allocation between ordinary and capital, and the difference in effective rate on a six-figure transaction is not trivial.
| Scenario | Federal treatment | Key authority | Workpaper support |
|---|---|---|---|
| Healthy insured sells policy (life settlement) | Two-tier: ordinary income up to CSV, capital gain above | Two-tier gain framework; Rev. Rul. 2020-05 on basis | CSV at sale date; total premiums paid |
| Terminally ill insured sells (viatical) | Generally excluded from income | IRC Sec. 101(g) | Physician certification of 24 months or less |
| Chronically ill insured sells | May be excluded subject to statutory conditions | IRC Sec. 101(g) | Certification plus qualified LTC services documentation |
| Any reportable policy sale | Information reporting by acquirer, issuer, and seller | IRC Sec. 6050Y | Forms 1099-LS and 1099-SB |
| Policy surrendered to the carrier instead | Gain over basis is ordinary income | General principles | Carrier surrender statement |
| Policy with an outstanding loan | Loan relief is part of the amount realized | General principles | Carrier loan balance at closing |
IRC Section 101(g): When It Is Not Taxable At All
Sellers who are terminally or chronically ill may receive proceeds free of federal income tax under IRC Section 101(g) when the statutory requirements are met. For terminal illness, that generally means a physician’s certification that death is reasonably expected within 24 months. Chronic illness has its own definition and its own conditions, including limits tied to qualified long-term care services.
Get the certification into the file. The exclusion is documentary, and reconstructing a physician certification two years later during an examination is not a position anyone wants to be in. The distinction between a viatical settlement and a standard life settlement drives the entire return treatment.
Kentucky State-Level Considerations
Kentucky imposes a flat individual income tax rate, which the General Assembly has been stepping down under a statutory trigger mechanism in recent years — verify the exact 2026 rate before computing a client’s projection. Kentucky’s starting point generally follows federal adjusted gross income with modifications, so the federal characterization above largely drives the state result.
Kentucky is also one of the few states with an inheritance tax, assessed by beneficiary class rather than on the estate, with close family generally exempt. Verify current classes, exemptions, and rates for 2026. Where a client is weighing settling a policy against leaving a death benefit to a non-exempt beneficiary class, the state tax outcome is part of the comparison.
Workpaper Checklist for a Settled Policy
Six items make the return defensible: the settlement contract showing gross proceeds; the closing or escrow statement showing net proceeds and any broker compensation; the carrier’s cash surrender value as of the sale date; documentation of total premiums paid; Forms 1099-LS and 1099-SB; and, where 101(g) is claimed, the physician certification.
Note the gap between gross and net. Compensation paid in the transaction does not automatically reduce the amount realized in the way clients assume, and the treatment should be confirmed against the closing documents rather than assumed from the deposit that hit the bank account.
How a Referral Works
The most useful thing a CPA can do is get involved before the transaction closes rather than after. With client permission, send one document: the policy cover page, showing carrier, product type, face amount, and issue date. The read is free, there is no engagement, and there is no obligation to you or the client.
First read is typically one to two business days. Four documents produce an indicative range: cover page, current in-force illustration, latest carrier statement, and a signed HIPAA authorization. A standard file runs roughly 60 to 120 days from complete documentation through funding. The client decides everything and can stop at any point before closing. Call (305) 209-7183.
This page is educational only and is not tax, legal, or investment advice for you or your client. Pine Lake Life Solutions does not provide tax counsel; positions should be confirmed against current authority. Nothing here is an offer to purchase any policy.
Frequently Asked Questions
What is a reportable policy sale?
Broadly, a transfer of an interest in a life insurance contract to a person who has no substantial family, business, or financial relationship with the insured apart from the acquirer’s interest in the contract. That characterization triggers IRC Section 6050Y information reporting by the acquirer, the issuer, and the seller.
How is basis computed after Rev. Rul. 2020-05?
Basis is generally total premiums paid, without the reduction for cost-of-insurance charges required under the older Rev. Rul. 2009-13 treatment. The 2017 Tax Cuts and Jobs Act made the change and Rev. Rul. 2020-05 conformed the guidance. Reconcile client records against the issuer’s reported investment in the contract.
Where does the split between ordinary income and capital gain fall?
At the policy’s cash surrender value. Gain from basis up to cash surrender value is ordinary income; gain above cash surrender value is capital gain. That makes the carrier’s cash surrender value as of the sale date a required workpaper item.
When are proceeds tax-free under IRC Section 101(g)?
Generally when the insured is terminally ill, supported by a physician’s certification that death is reasonably expected within 24 months, or chronically ill subject to the statute’s separate conditions. The exclusion is documentary, so the certification should be in the file at the time of the transaction.
What forms will my client receive?
Form 1099-LS from the acquirer reporting the payment, and Form 1099-SB from the issuer reporting investment in the contract and the surrender amount. Clients typically receive them months after closing and rarely know what they are for.
What is Kentucky’s individual income tax rate for 2026?
Kentucky uses a flat individual rate that the General Assembly has been reducing under a statutory trigger mechanism in recent sessions. Verify the exact current rate before running a client projection. Kentucky’s calculation generally starts from federal adjusted gross income with modifications.
Does Kentucky’s inheritance tax matter to this analysis?
It can. Kentucky assesses inheritance tax by beneficiary class rather than on the estate, with close family generally exempt and more remote or unrelated beneficiaries taxed. Verify current classes, exemptions, and rates for 2026 when comparing settling a policy against leaving the death benefit in place.
Should I be involved before the transaction closes?
Ideally yes. Characterization, basis substantiation, and the 101(g) certification are far easier to establish contemporaneously than to reconstruct at filing time. A free review on the policy cover page carries no obligation, so involving the CPA early costs nothing.
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 Taxes Kentucky
- Cash Surrender Value Life Insurance
- Life Settlement Vs Surrender
- How It Works Policy Options
- Life Settlement Licensing Kentucky
- 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.