Proceeds from the sale of a life insurance policy are taxed in three tiers: amounts up to the owner’s 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 long-term capital gain. That structure — and the fact that a terminally or chronically ill seller may receive proceeds income-tax-free under IRC Section 101(g) — is why the CPA is often the professional best positioned to catch a policy before it lapses.
You also see the policy earlier than anyone else. The premium is a recurring outflow on a cash-flow review, a line on a fiduciary return, or an entity-level expense on a business the client is winding down. This page is written for Ohio practitioners: the federal tax mechanics, Ohio’s regulatory and Medicaid context, and how a referral works.
If a client’s policy is on your desk, send the policy cover page with their permission for a free, no-obligation review — typically back in one to two business days. Call (305) 209-7183.
In This Article
- Send the Cover Page — Nothing Else Required
- The Three-Tier Computation
- IRC Section 101(g): When Proceeds Are Excluded Entirely
- Reporting, Entities, and the Traps
- Ohio Overlay: State Tax, Regulation, and Medicaid
- Where CPAs Actually Find These Policies
- How a Referral Works
- Educational Only
- Frequently Asked Questions
Send the Cover Page — Nothing Else Required
To find out whether a policy has secondary-market value, you send one page: the policy cover or declarations page showing carrier, policy number, policy type, face amount, and issue date. Redact whatever you consider sensitive, and send only with the client’s permission and consistent with your Section 7216 and AICPA confidentiality obligations regarding client information.
The screen is free and carries no obligation for you or the client. Nothing is submitted to the carrier. If you are already modeling a surrender in a projection, this gives you the other number to model against — before the client signs a surrender request that cannot be undone.
The Three-Tier Computation
Start with the framework the IRS set out in Revenue Rulings 2009-13 and 2009-14 and as modified by the Tax Cuts and Jobs Act. Tier one: proceeds up to the owner’s investment in the contract are a tax-free recovery of basis. Tier two: proceeds exceeding basis but not exceeding the cash surrender value are ordinary income — this is the same inside-buildup that would have been ordinary on a surrender. Tier three: proceeds above cash surrender value are generally long-term capital gain, assuming the policy was held more than a year.
The basis question is where the 2017 change matters. Rev. Rul. 2009-13 had required the seller to reduce basis by the cost-of-insurance charges consumed while the policy was in force, producing a higher gain on sale than on surrender for the same contract. TCJA Section 13521 reversed that adjustment for sales, aligning basis treatment. As of 2026 confirm the current statutory text and any subsequent guidance before you compute; this area has moved before and the amounts are large enough to warrant checking.
IRC Section 101(g): When Proceeds Are Excluded Entirely
Section 101(g) treats amounts received on the sale or assignment of a policy to a viatical settlement provider as an amount paid by reason of the insured’s death — meaning excluded from gross income — where the insured is terminally or chronically ill and the statutory requirements are met. For terminal illness, the general standard is a physician certification that the insured is reasonably expected to die within 24 months. For chronic illness, the exclusion is conditioned on the proceeds being used for qualified long-term care services not compensated by insurance, and the certification requirements differ.
Two practitioner points. First, the buyer must meet the definition of a viatical settlement provider, which generally means licensed in the insured’s state where licensing is required — verify this in the file, because the exclusion can turn on it. Second, get the physician certification contemporaneously and keep it; reconstructing it later is difficult. Confirm current Section 101(g) requirements and any 2026 inflation-adjusted per-diem limits applicable to chronic-illness cases before relying on the exclusion.
Reporting, Entities, and the Traps
Expect information reporting. Reportable policy sales carry reporting obligations under IRC Sections 6050Y and 101(a)(3), including statements to the seller and to the issuer, and issuers report the seller’s basis on the applicable form. Reconcile what the client receives against your own computation rather than accepting the reported figure — carrier basis records are frequently incomplete on older contracts, and reconstructing investment in the contract from decades of premium history is often the real work of the engagement.
Watch three additional traps. A policy subject to a policy loan produces amount realized that includes the debt relief, which surprises clients who expect net cash. A transfer-for-value history can taint the death benefit exclusion for a subsequent holder, so trace prior transfers on entity-owned contracts. And an entity-owned policy — key person, buy-sell, or split-dollar residual — puts the gain at the entity level with its own character and distribution consequences, plus potential corporate alternative minimum tax exposure for applicable corporations; confirm current thresholds for 2026.
| Layer of Proceeds | Character | Practitioner Note (2026 — confirm current rules) |
|---|---|---|
| Up to investment in the contract | Tax-free return of basis | Reconstruct premium history; carrier basis records are often incomplete |
| Basis to cash surrender value | Ordinary income | Same inside-buildup that would be ordinary on surrender |
| Above cash surrender value | Long-term capital gain | Assumes holding period exceeds one year |
| Basis adjustment for COI | Reversed by TCJA Sec. 13521 for sales | Rev. Rul. 2009-13 had required the reduction; verify current text |
| Terminally ill seller | Excluded under IRC Sec. 101(g) | Physician certification, generally 24 months or less |
| Chronically ill seller | Excludable, conditioned | Proceeds used for qualified LTC services; verify per-diem limits |
| Information reporting | IRC Sec. 6050Y reportable policy sales | Reconcile reported basis against your own computation |
| Policy loan outstanding | Debt relief in amount realized | Client’s net cash will be less than the gain figure |
Ohio Overlay: State Tax, Regulation, and Medicaid
Ohio imposes a graduated personal income tax; business income may qualify for the business income deduction and preferential rate, and municipal income tax is a separate layer that generally does not reach non-business investment income. Confirm current Ohio rates, brackets, and the treatment of capital gain for 2026 with the Ohio Department of Taxation before you project an after-tax number for a client.
On the transaction itself, Ohio Rev. Code Chapter 3916 governs viatical settlements and is administered by the Ohio Department of Insurance, covering provider and broker licensing, disclosures, and anti-STOLI rules. On the benefits side, Ohio’s long-term care Medicaid runs through the Ohio Department of Medicaid with MyCare Ohio managed care and the PASSPORT waiver; the individual countable-asset limit is $2,000 as of 2026, and life insurance is disregarded only when total face value across all policies is $1,500 or less. Ohio also has a filial-support statute on the books at R.C. 2919.21 (nonsupport) — verify how it is actually applied before mentioning it to a client.
Where CPAs Actually Find These Policies
Four places, reliably. A personal cash-flow review showing a five-figure annual premium the client cannot justify. A Form 1041 for a trust that pays insurance premiums and generates little else. A closely held business wind-down where key-person or buy-sell coverage was never addressed. And an estate or gift engagement where an ILIT funded under a much lower exclusion is still consuming annual exclusion gifts.
The screen that matters: insured roughly age 70 or older, or any age with a material adverse health change since issue; death benefit of $100,000 or more; and permanent, guaranteed universal life, or convertible term coverage. On magnitude, the GAO’s market study (GAO-10-775) found sellers typically received roughly 10 to 35 percent of face value — about four to eight times cash surrender value on average. Those ranges are why the tier-three capital gain layer exists at all.
How a Referral Works
With the client’s permission, you send the policy cover page and nothing more. The review is free, there is no obligation for you or the client, and the initial read typically comes back in one to two business days. If the client wants an indicative range, four documents move the file: the cover page, a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization for life expectancy underwriting.
A standard file runs roughly 60 to 120 days from application to funding, with proceeds held in independent escrow until the carrier confirms the ownership change; viatical files involving a terminal diagnosis can close faster. The client stays in control and can stop before signing a purchase agreement. Your role is the part nobody else can do — computing the after-tax comparison between surrender and sale, so the decision is made on real numbers.
Educational Only
This page is educational and is not tax, legal, or investment advice to you or to your client. Federal and Ohio rules change; verify current Internal Revenue Code provisions, IRS guidance, Ohio Department of Taxation positions, and Medicaid figures before advising. Pine Lake Life Solutions provides a free policy review and works with policies of $100,000 or more in death benefit, typically paying more than cash surrender value. Send the policy cover page or call (305) 209-7183; see the Education Center for background you can share with clients.
Frequently Asked Questions
How are life settlement proceeds taxed?
In three tiers: amounts up to the owner’s investment in the contract are a tax-free return of basis, amounts between basis and cash surrender value are ordinary income, and amounts above cash surrender value are generally long-term capital gain. Confirm current Internal Revenue Code provisions and IRS guidance for 2026 before computing.
Did TCJA change the basis calculation for a sale?
Yes. Rev. Rul. 2009-13 required reducing basis by cost-of-insurance charges on a sale; TCJA Section 13521 reversed that adjustment. Verify the current statutory text and any subsequent guidance, since this provision has been amended before and the dollar amounts involved are significant.
When are proceeds excluded from income under Section 101(g)?
Where the insured is terminally ill — generally certified by a physician as reasonably expected to die within 24 months — proceeds paid by a qualifying viatical settlement provider are treated as paid by reason of death and excluded. Chronically ill insureds may also qualify, conditioned on use for qualified long-term care services.
What information reporting applies?
Reportable policy sales trigger obligations under IRC Section 6050Y, including statements to the seller and the issuer, with the issuer reporting the seller’s basis. Reconcile those figures against your own reconstruction of investment in the contract rather than adopting them without review.
How does Ohio tax the gain?
Ohio imposes a graduated personal income tax that reaches the taxable portion of the proceeds; municipal income tax generally does not reach non-business investment income, and business income may qualify for the business income deduction. Confirm current rates and treatment with the Ohio Department of Taxation for 2026.
What happens if there is an outstanding policy loan?
The amount realized includes relief from the loan, so the taxable gain can substantially exceed the cash the client actually receives. Flag this before the client evaluates an offer, because the net-of-tax, net-of-loan figure is the only one that should drive the decision.
Which client policies are worth screening?
Insured roughly age 70 or older, or any age with a material adverse health change since issue; death benefit of $100,000 or more; and permanent, guaranteed universal life, or convertible term coverage. Non-convertible term and small final-expense policies generally do not qualify.
What does the referral cost the client or the firm?
Nothing. The policy review is free and creates no obligation for the CPA or the client, and nothing changes at the carrier unless the owner signs a purchase agreement. The initial screen on a cover page typically returns in one to two business days.
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Related Reading
- Life Settlement Vs Surrender
- Cash Surrender Value Life Insurance
- Life Settlement Taxes Ohio
- What Policies Qualify For Life Settlement
- Ohio 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.