When a client sells a life insurance policy, the federal tax result generally splits into three tiers: 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. That structure follows the IRS position set out in Rev. Rul. 2009-13 and refined by later guidance, including the 2017 tax law’s change to the basis calculation for life settlements. Confirm current guidance before you file.
You are also frequently the first professional to see the policy at all, because the premium shows up as a recurring outflow on a cash-flow review, on a Schedule of a closely held entity, or on a trust’s Form 1041 workpapers. Nobody else in the client’s advisory circle is looking at that line item every year.
This page is written for the CPA practicing in New York, where life settlements are governed by New York Insurance Law Article 78 and regulated by the Department of Financial Services. It is education, not tax advice to any specific taxpayer.
In This Article
The Three Tiers, Applied
Assume a client with a universal life policy: $1,000,000 death benefit, $180,000 of cumulative premiums paid, $60,000 cash surrender value, and a settlement offer. Tier one runs to basis. Tier two is the spread between basis and cash surrender value, taxed as ordinary income, and note that this tier can be zero or negative in the very common case where basis exceeds surrender value. Tier three is everything above cash surrender value, treated as long-term capital gain when the policy has been held long enough.
The basis question is where the practical work sits. Under Rev. Rul. 2009-13 the IRS originally reduced basis by the cost-of-insurance charges for a sale, producing a different basis for a sale than for a surrender. The 2017 tax legislation reversed that adjustment for reportable policy sales, restoring premiums paid as the basis measure. As of 2026, verify the current statutory and administrative position, including any subsequent guidance, before you compute a return.
Where the policy is a modified endowment contract, or where there is an outstanding policy loan, the analysis changes materially. Loan balances are treated as amount realized, which routinely surprises clients who assumed the loan simply reduced their check.
IRC Sec. 6050Y: The Forms Your Client Will Receive
Reportable policy sale reporting under IRC Sec. 6050Y applies to three parties. 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 amount. The seller receives copies and, understandably, calls you asking what to do with them.
The practical value of Form 1099-SB is that the carrier is telling you its computation of the client’s investment in the contract, which is your starting point for basis and a check against the client’s own records. If the client’s premium history and the carrier’s figure disagree, reconcile before filing rather than after a notice.
Reporting also reaches the issuer on transfers to foreign persons and on reportable death benefits, which is worth knowing when a policy has moved through a trust or an entity. As of 2026, confirm current form instructions and filing deadlines with the IRS.
Viatical Settlements Are a Different Animal
If the insured is terminally ill, IRC Sec. 101(g) generally excludes the proceeds from gross income entirely when a physician certifies a life expectancy of 24 months or less and the buyer is a qualified viatical settlement provider. The chronically ill rules under the same section are narrower and tie to payment for long-term care costs not otherwise compensated.
This distinction matters at intake, not at filing. A client with a terminal diagnosis who sells to a properly licensed viatical settlement provider may receive proceeds tax-free; the same client selling to a party that does not meet the statutory definition may not. Confirm the buyer’s status and the certification before assuming the exclusion applies, and verify current requirements for 2026.
| Tier | Amount | Federal character | Notes |
|---|---|---|---|
| 1 | Proceeds up to investment in the contract | Tax-free return of premium | Confirm basis against Form 1099-SB |
| 2 | Investment in contract up to cash surrender value | Ordinary income | Often zero when basis exceeds surrender value |
| 3 | Amount above cash surrender value | Long-term capital gain | Holding period applies |
| Special | Terminal illness, LE certified 24 months or less | Generally excluded under IRC Sec. 101(g) | Buyer must meet the statutory definition |
| Reporting | Reportable policy sale | Forms 1099-LS and 1099-SB | IRC Sec. 6050Y; confirm 2026 instructions |
New York State Treatment and the Article 78 Frame
New York generally starts from federal adjusted gross income for individual income tax purposes, so the federal characterization usually carries through to the New York return, subject to New York’s own modifications. As of 2026, confirm current New York State Department of Taxation and Finance guidance and any applicable modifications rather than assuming full conformity. New York City resident tax adds a layer for clients in the five boroughs.
Separately, the transaction itself is regulated. New York Insurance Law Article 78 licenses life settlement providers, brokers, and intermediaries; requires disclosures to the owner; and prohibits stranger-originated arrangements. The New York State Department of Financial Services administers it. When a client asks you whether a buyer is legitimate, DFS licensee information is the right place to point them.
Entity-Owned and Trust-Owned Policies
Two additional traps show up in a CPA practice. The first is transfer-for-value under IRC Sec. 101(a)(2), which can convert part of a future death benefit into ordinary income when a policy has been transferred for consideration, subject to statutory exceptions. That issue is live in buy-sell restructurings and split-dollar unwinds, both of which are also common sources of unwanted policies.
The second is the entity-level return. A corporation or LLC that sells a policy reports the gain at the entity level with its own character analysis, and employer-owned life insurance under IRC Sec. 101(j) carries notice and consent requirements that predate the sale and can affect the death benefit exclusion. A trust selling a policy reports on Form 1041 with the usual questions about whether income is distributed or accumulated and how the trust’s compressed brackets bite.
When a Client Is Heading Toward Medicaid
Because CPAs often catch the premium before anyone else, you are also often the first to see a client whose cash flow is failing under care costs. New York’s long-term care Medicaid runs through Nursing Home Medicaid and Managed Long Term Care, with an individual countable-asset limit far above the national norm, in the neighborhood of $33,000 (the 2025 figure was $32,396; as of 2026, confirm current figures). Cash surrender value on policies with aggregate face value above the $1,500 disregard threshold is generally a countable resource.
The tax point is timing. Proceeds are taxable in the year received, and a spend-down plan that ignores the tax bill leaves the client short. Coordinate with an elder law attorney so the settlement, the tax liability, and the spend-down all land in an order that works.
How a Referral Works
With the client’s permission, send the policy cover page. That alone tells us whether the policy is a candidate. If it is, we ask for three more documents to develop an indicative range: a current in-force illustration, the most recent carrier statement, and a HIPAA authorization signed by the insured.
Review is free, feedback typically comes back within one to two business days, and a full case generally runs about 60 to 120 days. General profile: insured around 70 or older, or any age with a material health change; $100,000 or more of death benefit; permanent, guaranteed universal life, or convertible term.
Your client is under no obligation, keeps control throughout, and can stop at any point before closing. You stay the client’s tax professional and should review the tax consequences of any offer before it is accepted. Free review: (305) 209-7183.
Frequently Asked Questions
Is basis for a life settlement reduced by cost-of-insurance charges?
Rev. Rul. 2009-13 originally required that reduction for a sale, and the 2017 tax legislation reversed it for reportable policy sales so that premiums paid generally measure basis. As of 2026, verify the current statutory text and any subsequent IRS guidance before computing a return.
What are Forms 1099-LS and 1099-SB?
They are the information returns required under IRC Sec. 6050Y for reportable policy sales. The acquirer files Form 1099-LS reporting the payment to the seller; the issuer files Form 1099-SB reporting the seller’s investment in the contract and the surrender amount.
How is an outstanding policy loan treated?
A loan balance repaid out of the transaction is generally treated as part of the amount realized, even though the client never sees that cash. Clients frequently misunderstand this, so raise it before they commit.
Are viatical settlement proceeds taxable?
IRC Sec. 101(g) generally excludes proceeds from income when the insured is terminally ill with a physician-certified life expectancy of 24 months or less and the buyer is a qualified viatical settlement provider. Confirm the buyer’s status and current requirements before relying on the exclusion.
Does New York conform to the federal treatment?
New York’s personal income tax generally starts from federal adjusted gross income, so the federal characterization usually carries over subject to New York modifications. As of 2026, confirm current New York State Department of Taxation and Finance guidance for the specific facts.
Who regulates the transaction in New York?
The New York State Department of Financial Services administers New York Insurance Law Article 78, which licenses life settlement providers, brokers, and intermediaries and imposes disclosure and anti-fraud requirements.
What does the client need to send for a review?
The policy cover page is enough to start. To develop an indicative range we also ask for a current in-force illustration, the latest carrier statement, and a HIPAA authorization from the insured.
Does the review cost anything?
No. The review is free with no obligation, and typical initial turnaround is one to two business days. A completed transaction generally takes about 60 to 120 days.
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Related Reading
- Life Settlement Taxes New York
- Cash Surrender Value Life Insurance
- Life Settlement Vs Surrender
- New York 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.