The single most useful thing a Michigan CPA can know about life settlements is that the basis rule changed in the client’s favor: under Rev. Rul. 2020-05, which conformed IRS guidance to the 2017 Tax Cuts and Jobs Act, a seller’s basis is generally total premiums paid and is no longer reduced by cost-of-insurance charges. Practitioners still working from Rev. Rul. 2009-13 are computing a smaller tax-free tier than the client is entitled to.
The rest of the analysis is a three-tier waterfall — return of premium, ordinary income, capital gain — plus IRC Sec. 6050Y information reporting on a reportable policy sale, plus the IRC Sec. 101(g) exclusion where the insured is terminally or chronically ill. Michigan’s flat individual income tax then applies to the taxable portion; as of 2026, confirm the current rate for the year of sale.
This page is written for tax professionals. It also covers the practice-development angle most CPAs miss: you see premium payments on bank statements and policy statements in the shoebox, which means you are often the first person positioned to notice that a client is paying for coverage they no longer need. Referrals take one document — the policy cover page, with the client’s permission. Free review, one to two day turnaround, no obligation. Call (305) 209-7183.
In This Article
Basis After Rev. Rul. 2020-05
Under Rev. Rul. 2009-13, a seller’s basis in a life insurance contract was reduced by the cost-of-insurance charges absorbed while the policy was in force, which on a long-held policy could be a very large reduction. The 2017 Tax Cuts and Jobs Act reversed that treatment, and Rev. Rul. 2020-05 conformed the Service’s published guidance accordingly.
The working rule now is that basis generally equals cumulative premiums paid. Documentation is the practical constraint: carriers can usually produce a premium history, and the transaction file from a properly run sale should preserve what you need. Where the policy has been through ownership changes, a split-dollar arrangement, a 1035 exchange, or loan activity, the basis computation deserves real attention rather than a default assumption.
The Three-Tier Waterfall
For a healthy seller, proceeds are allocated in this order:
- Tier one — up to basis. Tax-free return of premium.
- Tier two — basis up to cash surrender value. Ordinary income. This is the same tier a surrender would have produced.
- Tier three — above cash surrender value. Generally long-term capital gain, on the theory that the excess reflects the value of the contract as property rather than inside build-up.
The tier-three character is the reason the after-tax comparison so often favors a sale over a surrender even before the gross difference is considered: the incremental dollars a settlement produces are precisely the dollars taxed at capital rates. Run the client’s numbers both ways rather than assuming. Our explainer on cash surrender value gives the baseline figure the tiers hinge on, and life settlement taxes in Michigan works a full example.
IRC Sec. 101(g): When Proceeds Are Excluded Entirely
Where the insured is terminally ill — generally certified by a physician as reasonably expected to die within 24 months — amounts received on the sale or assignment of the policy to a qualified viatical settlement provider are treated as amounts paid by reason of death and excluded from income under IRC Sec. 101(g). A parallel rule applies for chronically ill insureds, with tighter conditions tied to costs of qualified long-term care and per-diem limitations.
Two cautions. First, the certification and the counterparty requirements are technical; the exclusion is not automatic just because the insured is very sick. Second, the difference in outcome between a taxable settlement and an excluded viatical is large enough that it should be identified before the transaction closes, not at return preparation. Confirm the current-year requirements before advising.
| Tier / Item | Federal Treatment | Preparer Note |
|---|---|---|
| Proceeds up to basis | Tax-free return of premium | Basis = cumulative premiums paid (Rev. Rul. 2020-05) |
| Basis to cash surrender value | Ordinary income | Identical tier on a surrender |
| Above cash surrender value | Long-term capital gain | The tier only a sale produces |
| Terminally ill insured | Excluded under IRC Sec. 101(g) | Physician certification generally 24 months or less; confirm counterparty and current requirements |
| Chronically ill insured | Potential exclusion under IRC Sec. 101(g) | Conditions tied to qualified LTC costs and per-diem limits |
| Information reporting | IRC Sec. 6050Y on a reportable policy sale | Reconcile reported investment in contract to your basis workpaper |
| Michigan income tax | Flat individual rate on the taxable portion | As of 2026, confirm the current rate for the year of sale |
| Superseded guidance | Rev. Rul. 2009-13 basis reduction for cost of insurance | No longer applied to sales after the 2017 Act change |
Section 6050Y Reporting and What Lands in the Client’s Mail
A reportable policy sale triggers IRC Sec. 6050Y information reporting. The acquirer reports the acquisition of the interest, the issuing carrier reports the seller’s investment in the contract, and the seller receives the corresponding information return. Expect the client to call you the moment it arrives.
Preparer implications are straightforward but worth noting on the workpapers: reconcile the reported investment in the contract against your own basis computation, because carrier-reported figures and a defensible premium history do not always agree. Where they diverge, document the reconciliation rather than adopting either number silently. Michigan’s individual income tax is then computed on the taxable federal amount; confirm the current rate.
Why the CPA Often Sees It First
Advisors see policies when clients volunteer them. CPAs see the premium debits. In practice, three artifacts routinely surface a candidate policy:
- Recurring premium payments on bank or brokerage statements for coverage the client never mentions.
- Carrier annual statements in the client’s document bundle, often for a universal life contract quietly consuming its own cash value.
- Business transitions — a sold company, a bought-out partner, a terminated split-dollar arrangement — that leave key-person or buy-sell coverage without a purpose.
The screen for a policy worth reviewing is an insured roughly 70 or older, or any age with a material adverse health change, with $100,000 or more of death benefit on a permanent, guaranteed universal life, or convertible term contract. See what policies qualify. The value at stake is not trivial: federal market data (GAO-10-775) put typical settlements at roughly 10% to 35% of face value, about four to eight times surrender value on average.
Professional Standards and Michigan Practice Notes
CPAs in Michigan are licensed through the state’s Board of Accountancy under LARA, and the AICPA Code of Professional Conduct plus the Statements on Standards for Tax Services frame the engagement. Two points recur.
First, independence and commissions. A CPA in public practice who would receive a commission or referral fee in connection with a client transaction has an independence and disclosure problem to work through under the applicable rules; the clean approach is an informational referral with no compensation and the client dealing directly.
Second, scope. Explaining the tax consequences of a proposed sale is squarely tax practice. Recommending that a client sell a specific policy, or opining on suitability, edges into advisory territory that may implicate other licensing regimes. Describe the rules, model the outcomes, and let the client decide with independent insurance and legal counsel.
Educational information for professionals only. Nothing here is tax, legal, or investment advice, and it does not create a client relationship. Verify all citations, rates, and thresholds for the current year before relying on them.
How a Referral Works
You send one thing: the policy cover page, with the client’s permission. That is the declarations page listing the carrier, policy number, face amount, policy type, and issue date. Nothing financial, nothing medical, and you may redact anything you would rather not transmit.
The review costs nothing and obligates no one. An initial read typically comes back in one to two business days with a plain answer on whether the policy is a realistic secondary-market candidate. To develop an indicative range, three additional documents complete the file — a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization. Standard files run about 60 to 120 days from application to funding, so a client planning around a tax year should start early.
The client stays in control the entire time and can stop at any point; nothing changes on the policy until they sign a purchase agreement and funds are in escrow. Call (305) 209-7183, or start with the Education Center.
Frequently Asked Questions
What is a seller’s basis in a life insurance policy today?
Generally cumulative premiums paid. Rev. Rul. 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act, eliminating the cost-of-insurance reduction that Rev. Rul. 2009-13 had required, which enlarges the tax-free tier on long-held policies.
How are settlement proceeds allocated for tax purposes?
Proceeds up to basis are a tax-free return of premium, the amount from basis up to cash surrender value is ordinary income, and anything above cash surrender value is generally long-term capital gain. Michigan’s individual income tax then applies to the taxable portion at the current flat rate.
When are proceeds excluded from income entirely?
Under IRC Sec. 101(g), amounts received by a terminally ill insured on a sale to a qualified viatical settlement provider are treated as paid by reason of death and excluded, with terminal illness generally certified by a physician as death reasonably expected within 24 months. A parallel chronically ill rule exists with tighter conditions tied to qualified long-term care costs.
What reporting will my client receive?
A reportable policy sale triggers IRC Sec. 6050Y reporting, with the acquirer reporting the acquisition and the issuing carrier reporting the seller’s investment in the contract, plus an information return to the seller. Reconcile the carrier-reported investment figure against your own premium-history basis computation and document any difference.
Is a settlement better after tax than a surrender?
Frequently, because the incremental dollars a settlement produces above cash surrender value are the dollars generally taxed at long-term capital gain rates rather than as ordinary income. Model both outcomes with the client’s actual basis, surrender value, and bracket rather than assuming.
Can I accept a referral fee for sending a client for a policy review?
A CPA in public practice who would receive a commission or referral fee in connection with a client transaction faces independence and disclosure obligations under the applicable professional standards. The clean approach is an uncompensated informational referral with the client dealing directly.
How would I spot a candidate policy in a tax engagement?
Look for recurring premium debits on statements, carrier annual statements in the client’s document bundle, and business transitions that leave key-person or buy-sell coverage without a purpose. The qualifying screen is an insured roughly 70 or older, or any age with a material health change, with $100,000 or more of death benefit.
How long does a settlement take, and does timing affect the tax year?
A standard file runs roughly 60 to 120 days from application to funding, so a client trying to land the transaction in a particular tax year should begin well before year-end. Terminal or chronic illness files often move faster.
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Related Reading
- Life Settlement Vs Surrender
- What Policies Qualify For Life Settlement
- Cash Surrender Value Life Insurance
- Life Settlement Taxes Michigan
- 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.