Since Rev. Rul. 2020-05, a seller’s basis in a life insurance policy is generally total premiums paid, no longer reduced by cost-of-insurance charges — which means the taxable portion of a policy sale is materially smaller than the pre-2018 rules produced. If your working assumption still comes from Rev. Rul. 2009-13, the numbers on your workpapers are wrong in the client’s disfavor.
This matters more in South Carolina than the state’s size suggests. South Carolina is among the fastest-growing retirement destinations in the country, with sustained retiree in-migration into the Upstate, the Midlands and the Lowcountry, and clients arriving with decades-old permanent policies purchased elsewhere. Settlements involving South Carolina residents are governed by S.C. Code Title 38, Chapter 70, administered by the South Carolina Department of Insurance.
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In This Article
- Basis After Rev. Rul. 2020-05
- The Three-Tier Split, Applied
- IRC Sec. 6050Y Information Reporting
- The IRC Sec. 101(g) Exclusion for Terminal and Chronic Illness
- State-Level Considerations in South Carolina
- When the Client Is Also Doing Medicaid Planning
- How a Referral Works
- Frequently Asked Questions
Basis After Rev. Rul. 2020-05
Under Rev. Rul. 2009-13, a seller had to reduce basis by the cost-of-insurance charges absorbed while the policy was in force, which on an older policy could consume most of the premium history and inflate taxable gain. The 2017 Tax Cuts and Jobs Act eliminated that reduction, and Rev. Rul. 2020-05 conformed the IRS position accordingly.
The practical result: basis is generally total premiums paid. The workpaper problem is documentation, not doctrine — clients rarely have thirty years of premium records. Carrier premium histories, annual statements, and in some cases a written carrier-provided basis figure are the substitutes. Start requesting them early, because carriers are slow and the reporting deadline is not.
The Three-Tier Split, Applied
Proceeds up to basis: tax-free return of premium. Proceeds from basis up to cash surrender value: ordinary income. Proceeds above cash surrender value: long-term capital gain, assuming the policy was held long enough. On a surrender, by contrast, the entire gain over basis is ordinary income and there is no capital-gain tier at all, because there are no proceeds above cash surrender value.
That character difference is the whole reason a CPA should want the comparison run before a client surrenders. For a client with meaningful ordinary-income exposure, the difference between an ordinary-income surrender and a sale with a capital-gain component is not rounding.
IRC Sec. 6050Y Information Reporting
A reportable policy sale pulls in IRC Sec. 6050Y. The acquirer reports the acquisition and furnishes statements to the seller and to the issuer; the issuer reports the seller’s investment in the contract. Expect the associated forms in the following filing season and reconcile them against the client’s own premium history rather than accepting the issuer’s basis figure without review.
Where the buyer subsequently transfers the policy, or where the policy has moved between related entities, the transfer-for-value rules and their exceptions determine whether the death benefit remains income-tax-free downstream. That analysis belongs with the transaction documents, not with the 1040.
| Tier | Amount | Character on a sale | Authority to cite |
|---|---|---|---|
| 1 | Up to basis | Tax-free return of premium | Rev. Rul. 2020-05 (basis = total premiums paid) |
| 2 | Basis to cash surrender value | Ordinary income | Ordinary income on inside build-up |
| 3 | Above cash surrender value | Long-term capital gain | Capital character for the excess |
| Surrender comparison | All gain over basis | Ordinary income | No capital-gain tier available |
| Terminal illness | Full proceeds | Generally excluded from income | IRC Sec. 101(g), physician certification of 24 months or less |
| Reporting | Reportable policy sale | Acquirer and issuer filings; statements to seller | IRC Sec. 6050Y |
The IRC Sec. 101(g) Exclusion for Terminal and Chronic Illness
Where the insured is terminally ill — generally a physician certification of a life expectancy of 24 months or less — proceeds from a viatical settlement are generally excluded from gross income under IRC Sec. 101(g), provided the statutory requirements are met, including the status of the purchaser. A chronically ill insured may qualify for an exclusion on a more limited basis tied to unreimbursed long-term care costs.
This is the highest-value determination in the analysis, because it can move a six-figure transaction from taxable to excluded. It also has the strictest documentation requirements, so the physician certification and the buyer’s licensing status need to be in the file before the return is prepared, not reconstructed afterward.
State-Level Considerations in South Carolina
South Carolina imposes an individual income tax with a starting point tied to federal taxable income, so federal characterization generally drives the state result — but confirm the current-year South Carolina treatment of capital gains, including the state’s long-term capital gain deduction, against the Department of Revenue’s 2026 guidance before modeling. Rates and deduction mechanics have been adjusted repeatedly in recent years.
Regulatory oversight of the transaction itself sits with the South Carolina Department of Insurance under Title 38, Chapter 70, covering provider and broker licensure, required disclosures, and the owner’s rescission right after funding. That is a compliance question for the transaction, not a tax question, but clients ask both in the same phone call.
When the Client Is Also Doing Medicaid Planning
Proceeds are a countable resource in the month received. Healthy Connections Medicaid and the Community Choices waiver apply a $2,000 individual countable-asset limit as of 2026, so a settlement improves eligibility only after the cash is converted into exempt or permitted form. A documented arm’s-length sale, unlike a gift, should not trigger a penalty period under the federal 60-month look-back.
Two tax touchpoints follow. Income recognized in the settlement year can affect other calculations for that year, including Medicare IRMAA two years later. And a caregiver agreement funded with proceeds creates taxable income to the caregiver and potential household-employment obligations — a detail families almost never anticipate.
How a Referral Works
With client permission, send only the redacted policy cover page. That single page supports a free preliminary read, typically returned in one to two business days, and it commits your client to nothing.
For an indicative range, four documents complete the file: the policy cover page, a current in-force illustration, the most recent carrier statement, and a signed HIPAA authorization. A standard file runs roughly 60 to 120 days from complete documents to funding. The general screen is an insured roughly 70 or older, or any age with a material health change, a death benefit of $100,000 or more, and permanent coverage or convertible term. The review is free, no obligation attaches to you or your client, and the client stays in control of the policy throughout.
This page is educational only. It is not legal, tax or investment advice, and it is not an offer to purchase any policy. Pine Lake Life Solutions provides a free policy review; your client decides what to do with the information.
Frequently Asked Questions
What is a seller’s basis in a life insurance policy today?
Generally total 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. That materially reduces taxable gain on older policies.
How do the three tiers work?
Proceeds up to basis are a tax-free return of premium; proceeds between basis and cash surrender value are ordinary income; proceeds above cash surrender value are long-term capital gain. A surrender produces only the first two tiers, with all gain over basis taxed as ordinary income.
What reporting should I expect for the client?
A reportable policy sale triggers IRC Sec. 6050Y. The acquirer reports the purchase and furnishes statements to the seller and issuer, and the issuer reports the seller’s investment in the contract. Reconcile the reported basis against the client’s own premium history.
When are proceeds income-tax-free?
Generally when the insured is certified terminally ill by a physician with a life expectancy of 24 months or less and the other requirements of IRC Sec. 101(g) are satisfied, including the purchaser’s status. A chronically ill insured may qualify on a narrower basis tied to unreimbursed long-term care costs.
Where do I get basis documentation for a thirty-year-old policy?
Request the carrier’s premium history and annual statements, and ask whether the carrier will state the investment in the contract in writing. Start early, because carrier turnaround is slow relative to filing deadlines.
How does South Carolina tax the gain?
South Carolina’s individual income tax starts from federal taxable income, so federal characterization generally drives the state result. Confirm the current treatment of long-term capital gains, including the state’s capital gain deduction, against South Carolina Department of Revenue guidance for 2026.
Does a settlement affect the client’s Medicaid picture?
Cash is a countable resource in the month received, and Healthy Connections Medicaid uses a $2,000 individual asset limit as of 2026. A documented arm’s-length sale should not create a penalty period under the 60-month look-back, unlike a gift of the policy.
Is a policy review going to cost the client anything?
No. The review is free and carries no obligation. It produces a number your client and their advisors can compare against the carrier’s cash surrender value before deciding anything.
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Related Reading
- Life Settlement Taxes South Carolina
- Cash Surrender Value Life Insurance
- Life Settlement Vs Surrender
- South Carolina Medicaid Asset Income Limits
- How It Works Policy Options
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.