Sale proceeds from a life insurance policy are taxed in three tiers: amounts up to basis are a tax-free return of premium, amounts between basis and cash surrender value are ordinary income, and anything above cash surrender value is generally long-term capital gain. That framework, plus the IRC § 6050Y reporting regime, is most of what a Maryland CPA needs to handle the return correctly — and it is why clients bring you the forms with no idea what they are.
The other reason this lands on your desk first is cash flow. You are often the earliest professional to see a lapsing policy, because the premium appears as a recurring outflow on a cash-flow review, on a retiree’s budget, or on a trust’s Form 1041 fiduciary return. By the time an attorney or advisor sees it, the grace period may already be running.
Send us a redacted policy cover page. With the client’s permission, one page starts a free review, the initial read comes back in one to two business days, and there is no obligation for you or the client. Call (305) 209-7183.
In This Article
The Three Tiers, Applied
Tier one is basis. Under current law, basis in a life insurance contract for sale purposes is generally total premiums paid, without the reduction for cost of insurance that the 2017 legislation eliminated for sales — a change that materially improved seller outcomes. Proceeds up to that basis come back tax free.
Tier two runs from basis to cash surrender value and is ordinary income, mirroring the surrender result. Tier three is everything above cash surrender value, generally treated as long-term capital gain when the contract was held long term. A viatical sale by a terminally ill insured is a different animal entirely and is generally excluded from income under IRC § 101(g) when the certification requirements are met.
Forms 1099-LS and 1099-SB
IRC § 6050Y imposes reporting obligations on multiple parties to a reportable policy sale. The acquirer files Form 1099-LS reporting the payment to the seller and notifies the issuer. The issuer files Form 1099-SB reporting the seller’s investment in the contract and the policy’s surrender value. Your client will receive paperwork from parties they have never heard of and will call you.
Practical file note: reconcile the 1099-SB investment-in-contract figure against the client’s own premium records before you rely on it. Carrier-reported basis figures are sometimes incomplete where the policy changed ownership, was part of a 1035 exchange, or had loans and withdrawals. Our Maryland life settlement tax overview walks the same ground for a lay reader if you want something to hand the client.
Maryland State-Level Treatment
Maryland does not provide a preferential rate for long-term capital gain. Gain flows into Maryland taxable income and is taxed at ordinary state rates, with a county or Baltimore City local income tax stacked on top — confirm the current 2026 state brackets and local rates with the Comptroller of Maryland before you model an after-tax number. For a client in a high-rate county, that stack meaningfully changes the comparison between surrendering and selling.
Two other Maryland items are worth having at hand when the file is estate-adjacent: Maryland imposes a state estate tax with an exemption held at the $5 million level rather than tracking the federal amount, and a separate inheritance tax on transfers to certain non-lineal beneficiaries. Verify current thresholds; they change the reason a client is holding the policy at all.
| Tier | Amount range | Federal character | Maryland treatment |
|---|---|---|---|
| 1 | Up to basis (generally total premiums paid) | Tax-free return of investment in the contract | Not included in Maryland taxable income |
| 2 | Basis to cash surrender value | Ordinary income | Ordinary state rates plus county local tax |
| 3 | Above cash surrender value | Generally long-term capital gain | No preferential state rate; taxed as ordinary income |
| Viatical | Full proceeds, terminally ill insured | Generally excluded under IRC Sec. 101(g) | Generally follows the federal exclusion; verify |
| Reporting | Any reportable policy sale | Forms 1099-LS (acquirer) and 1099-SB (issuer) | Reconcile against client premium records |
Where You Will Spot the Policy
Four places in a normal engagement. A recurring premium draft on a cash-flow statement for a retired client with no dependents. A Form 1041 for an ILIT whose only activity is a premium payment funded by grantor gifts. A 1099-R from a partial surrender or a policy loan the client took to cover a premium. And a business return where key-person or buy-sell coverage is still deductible-adjacent on the books after the insured left the company.
Each of those is a signal that the coverage may have outlived its purpose. The question to ask is not tax-technical: does anyone still need this death benefit, and what is the policy actually worth?
Modeling Surrender Against Sale
A clean comparison has four lines: gross proceeds, basis recovery, ordinary income component, capital gain component, then the state and local layer. Surrender caps gross proceeds at the carrier’s number and puts everything above basis into ordinary income. A sale can produce a higher gross with a portion taxed at capital gain rates — but the arithmetic only works if the policy actually has secondary-market value.
Commonly cited industry ranges run roughly 10% to 35% of face value, and GAO-10-775 found settlement proceeds substantially exceeded cash surrender value on the policies studied. Do not model from a range. Get a current valuation and then run the numbers. Our life settlement vs. surrender page frames the same comparison for the client.
Independence and Scope
You are not being asked to recommend a transaction or to opine on suitability. The role that fits a CPA cleanly is the one you already have: identify that an asset exists, quantify the after-tax outcome of each disposition, and tell the client to obtain an independent valuation and independent legal advice before acting. AICPA independence and integrity standards, and the Maryland Board of Public Accountancy’s rules of conduct, frame any compensation arrangement — verify before entering into one.
How a Referral Works
With the client’s permission you send one document: the policy cover page. It identifies the carrier, product type, face amount, and issue date — enough for a preliminary read on whether the policy is worth pursuing. No fee, no engagement, no obligation on either side.
The first read typically comes back in one to two business days. If the policy looks viable, three more documents produce an indicative range: a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization. A standard file runs roughly 60 to 120 days from complete documentation through funding.
Your client stays in control the entire time, can stop at any point before closing, and can have you model any offer before it is accepted. Call (305) 209-7183 or send the cover page for a free 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 tax or legal counsel; independent professionals should review any transaction before it is executed.
Frequently Asked Questions
What is the client’s basis in a policy sale?
For sales, basis is generally total premiums paid, without the reduction for cost of insurance charges that applied before the 2017 change. Loans, withdrawals, and prior 1035 exchanges complicate the figure. Reconcile the Form 1099-SB investment-in-contract number against the client’s own records rather than accepting it at face value.
Who files Form 1099-LS and who files 1099-SB?
Under IRC Section 6050Y, the acquirer of the policy files Form 1099-LS reporting the payment to the seller and notifies the issuing carrier. The issuer then files Form 1099-SB reporting the seller’s investment in the contract and the policy’s surrender value. The seller receives copies of both.
Does Maryland tax the capital gain portion at a lower rate?
No. Maryland has no preferential long-term capital gain rate; gain is taxed at ordinary state rates, with a county or Baltimore City local income tax added on top. Confirm the 2026 state brackets and applicable local rate with the Comptroller of Maryland before producing an after-tax projection.
How is a viatical settlement taxed differently?
When a physician certifies that the insured is terminally ill within the meaning of IRC Section 101(g), typically a life expectancy of 24 months or less, proceeds are generally excluded from gross income. The certification and documentation requirements are specific, so the file should support the exclusion before the return is filed.
What if the seller is an ILIT rather than the individual?
The trust is the seller, and the character of the gain and the reporting follow the trust. Grantor trust status changes where the income lands on the return. Coordinate with trust counsel on both the trustee’s authority to sell and the reporting posture before the transaction closes.
Can a CPA be compensated for a referral?
Compensation arrangements are governed by AICPA rules of conduct, the Maryland Board of Public Accountancy’s requirements, and state insurance licensing law. Any arrangement should be verified against all three before it is entered into. The policy review itself is free and carries no obligation for either you or the client.
How long does the process take?
A standard file runs roughly 60 to 120 days from complete documentation through funding. That timing matters for year-end planning, since a sale that funds in January lands in a different tax year than one that funds in December. The free initial read on a cover page typically returns in one to two business days.
What documents should the client gather?
Four: the policy cover page, a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization. For your side of the work, add the client’s premium payment history and any records of loans, withdrawals, or prior exchanges that affect basis.
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Related Reading
- Life Settlement Taxes Maryland
- Life Settlement Vs Surrender
- Cash Surrender Value Life Insurance
- What Policies Qualify For Life Settlement
- 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.