The single fact most worth carrying into a client meeting is that basis on a life settlement is generally total premiums paid — the cost-of-insurance reduction that Rev. Rul. 2009-13 imposed was eliminated by the 2017 Tax Cuts and Jobs Act, and Rev. Rul. 2020-05 conformed IRS guidance to that change. Practitioners still working from a 2010-era memo are overstating gain, sometimes by a large amount, on a transaction the client has already closed.
The rest of the analysis is mechanical once basis is right: three tiers of character, an information-reporting regime under IRC Section 6050Y, and a possible full exclusion under IRC Section 101(g) for a terminally or chronically ill insured. Where CPAs add the most value is early — before the client surrenders a policy, when the choice between surrender and sale still exists and the tax character of the two paths differs.
Send us a redacted policy cover page. With client permission, one page is enough for a free initial read, typically returned in one to two business days, with no obligation to you or the client. Call (305) 209-7183.
In This Article
Basis After TCJA and Rev. Rul. 2020-05
Under Rev. Rul. 2009-13, a seller’s basis in a policy was reduced by the cost-of-insurance charges attributable to the coverage actually provided — a figure that was frequently unknowable without a carrier cooperating. The 2017 Act removed that adjustment for sales after its effective date, and Rev. Rul. 2020-05 restated the government’s position accordingly.
The working rule is that basis is generally total premiums paid. That is a number the client’s records or the carrier can usually produce. Where the policy has a loan, a partial surrender history, dividends taken in cash, or a Section 1035 exchange in its past, the calculation gets more involved and the carrier’s basis reporting should be reconciled rather than accepted. Confirm the current authority for the year at issue before signing a return.
The Three Tiers, Stated Cleanly
Tier one: proceeds up to basis are a tax-free return of premium. Tier two: proceeds between basis and cash surrender value are ordinary income — this is the same inside build-up a surrender would have produced, so nothing about a sale creates it. Tier three: proceeds above cash surrender value are long-term capital gain, assuming the holding-period requirement is met.
The practical consequence is that a sale and a surrender are not merely different-sized checks. They have different characters. A surrender produces tiers one and two only. A sale can reach tier three, and for a client in a high bracket the after-tax spread between the two paths is larger than the pre-tax spread. Our Missouri life settlement tax page works through the arithmetic.
Section 101(g): When Proceeds Come Out Tax-Free
IRC Section 101(g) treats certain accelerated death benefits and viatical settlement payments as amounts paid by reason of the death of the insured, which means they can be received income-tax-free. Terminal illness generally requires a physician certification that the insured is reasonably expected to die within 24 months. Chronic illness has its own certification requirements and per-diem limitations that must be tested rather than assumed.
The purchaser matters too. The favorable treatment generally requires that the buyer be a licensed viatical settlement provider in the applicable state, or meet the requirements the Code specifies where the state does not license. That makes provider licensure a tax fact, not just a consumer-protection fact — and a reason to confirm authority through the Missouri Department of Commerce and Insurance under Chapter 376 RSMo before closing.
| Amount received | Character | Authority / note |
|---|---|---|
| Up to basis | Tax-free return of premium | Basis generally equals total premiums paid post-TCJA |
| Basis to cash surrender value | Ordinary income | Same tier produced by a surrender |
| Above cash surrender value | Long-term capital gain | Reachable only on a sale, not a surrender |
| Terminally ill insured | May be fully excluded | IRC Sec. 101(g); generally 24-month physician certification |
| Chronically ill insured | May be excluded within limits | IRC Sec. 101(g) certification and per-diem rules apply |
| Basis calculation change | No COI reduction | Rev. Rul. 2020-05 superseding Rev. Rul. 2009-13 treatment |
| Any reportable policy sale | Information reporting | IRC Sec. 6050Y; Forms 1099-LS and 1099-SB |
Section 6050Y Reporting and What Lands in the Client’s Mail
A reportable policy sale triggers information reporting. In broad terms the acquirer files Form 1099-LS reporting the payment to the seller, and the issuing carrier files Form 1099-SB reporting the seller’s investment in the contract and the policy’s surrender value. Copies go to the seller. Transfers of an interest to a foreign person carry their own reporting wrinkles.
Two practical points. First, the carrier’s reported investment in the contract is a starting point, not a conclusion, and should be reconciled against the client’s own premium history. Second, clients who were not warned tend to call in a panic when unexpected forms arrive in January. A one-paragraph heads-up at closing prevents that call.
Missouri State-Level Treatment
Missouri individual income tax generally begins from federal adjusted gross income, so the federal character analysis largely drives the state result. One Missouri-specific development is worth flagging: the state enacted a capital gains deduction for individuals beginning with the 2025 tax year. If it applies and remains in effect, it changes the after-tax comparison between a surrender (ordinary income at tier two) and a sale (capital gain at tier three) more sharply in Missouri than in most states.
Because that provision is recent and its scope, effective dates, and any subsequent amendments or litigation may have moved, verify its current 2026 status with the Missouri Department of Revenue before relying on it in a projection. Missouri CPAs are licensed by the Missouri State Board of Accountancy, and the usual AICPA standards on tax positions and written advice apply here exactly as they do anywhere else.
Where the CPA Catches the Case First
CPAs see the trigger events before anyone else does. A 1099-R from a policy surrender that has already happened. A client’s Schedule A or personal cash flow showing a large annual premium on coverage for a business that was sold. An estate projection where a decades-old policy is still carried at face value in the client’s own mental balance sheet.
The screen is simple: insured roughly 70 or older, or any age with a material health change since issue; $100,000 or more of death benefit; and permanent coverage, guaranteed universal life, or term still inside its conversion window. Where the client is also approaching long-term care, note that Missouri’s MO HealthNet for the Aged, Blind and Disabled resource standard is indexed and has run near $5,900 for an individual in 2026 — higher than the $2,000 most states use, and worth verifying before it goes in a plan.
How a Referral Works
With client permission, send the policy cover page and nothing else. Carrier, product type, face amount, and issue date are enough for a preliminary read. There is no fee, no engagement, no obligation, and no compensation to you.
Initial turnaround is typically one to two business days. If the policy is viable, an indicative range requires three additional documents: a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization. A standard file runs about 60 to 120 days from complete documentation through funding, and viatical cases involving a certified terminal illness often move faster.
The client stays in control throughout and can stop at any point before closing. You should review the tax consequences of any offer before it is accepted — that is the part of this transaction the client cannot evaluate alone. 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. Pine Lake Life Solutions does not provide tax or legal counsel; the client’s own CPA and counsel should review any transaction before it is executed.
Frequently Asked Questions
Is basis still reduced by cost-of-insurance charges?
No. The 2017 Tax Cuts and Jobs Act eliminated that reduction and Rev. Rul. 2020-05 conformed IRS guidance, so basis is generally total premiums paid. Practitioners working from Rev. Rul. 2009-13 will overstate gain. Confirm the authority applicable to the year at issue before signing the return.
How is the gain split between ordinary income and capital gain?
Proceeds up to basis are a tax-free return of premium, proceeds between basis and cash surrender value are ordinary income, and proceeds above cash surrender value are long-term capital gain. A surrender can only ever reach the first two tiers, which is why character matters as much as amount.
When are proceeds completely income-tax-free?
IRC Section 101(g) can exclude payments to a terminally or chronically ill insured when the certification requirements are met, generally a physician certification of 24 months or less for terminal illness. Chronic illness has separate certification and per-diem limitations. The purchaser’s licensing status is also part of the test.
What forms should the client expect after closing?
Generally Form 1099-LS from the acquirer and Form 1099-SB from the issuing carrier, both under IRC Section 6050Y. The carrier’s reported investment in the contract should be reconciled against the client’s own premium records rather than accepted at face value.
Does Missouri tax the gain differently from federal?
Missouri generally starts from federal adjusted gross income. The state enacted a capital gains deduction for individuals beginning with the 2025 tax year, which if applicable would widen the after-tax advantage of capital-gain character. Verify its current 2026 scope and status with the Missouri Department of Revenue before relying on it.
Does a policy loan change the calculation?
Yes. Outstanding loans, prior partial surrenders, dividends taken in cash, and any Section 1035 exchange history all affect basis and amount realized. These are the cases where the carrier’s reporting and the client’s records most often disagree, and reconciliation is worth the time.
How much does a settlement typically produce relative to surrender value?
Commonly cited industry ranges run roughly 10% to 35% of face value, and the GAO’s 2010 report (GAO-10-775) found proceeds substantially above cash surrender value on the policies studied. Pricing is policy-specific, so a current valuation is the only figure worth putting in a projection.
Can I refer a client without getting involved in the transaction?
Yes. Many CPAs simply tell the client the market exists and let them request a free review directly. There is no fee to you and no referral compensation. Reviewing the tax consequences of any offer before it is accepted is where your involvement matters most.
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Related Reading
- Life Settlement Taxes Missouri
- Life Settlement Vs Surrender
- Cash Surrender Value Life Insurance
- Life Settlement Licensing Missouri
- 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.