For a policy sale in 2026, the seller’s basis is generally total premiums paid — Rev. Rul. 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change and removed the cost-of-insurance reduction that Rev. Rul. 2009-13 had imposed on life settlement sellers. That single change moves real dollars on a long-held universal life policy, and it is the fact most often stated incorrectly in materials written before 2020.
From there the computation is a three-tier stack: 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 generally long-term capital gain. Where the insured is terminally or chronically ill and the certification requirements are met, IRC Section 101(g) can make the proceeds income-tax free. A reportable policy sale also triggers information reporting under IRC Section 6050Y.
This page is written for the tax professional and is educational only — not tax, legal or investment advice to you or your client. If a client is weighing a surrender, the policy can be priced first: send the cover page with the client’s permission for a free, no-obligation review. (305) 209-7183.
In This Article
- Send a Redacted Policy Cover Page
- Basis After Rev. Rul. 2020-05
- The Three-Tier Stack, Applied
- Section 101(g): When Proceeds May Be Income-Tax Free
- Section 6050Y Reporting and What Your Client Will Receive
- Texas Context: Chapter 1111A, STAR+PLUS and MERP
- The Modeling Conversation to Have Before a Surrender
- How a Referral Works
- Frequently Asked Questions
Send a Redacted Policy Cover Page
Before the tax question there is a valuation question, and it is answerable in a couple of days. With the client’s permission, send the policy cover page — carrier, product type, face amount, issue date, insured’s date of birth. Redact the policy number if you prefer. The review is free and returns in one to two business days.
No fee, no obligation, no purchase implied. Pine Lake Life Solutions provides education and free policy reviews; any transaction is completed only through properly licensed channels appropriate to the client’s situation. (305) 209-7183.
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 the policy had absorbed — which meant a settlement seller and a surrendering owner were computing basis two different ways on the same contract. The 2017 Tax Cuts and Jobs Act reversed that treatment, and Rev. Rul. 2020-05 conformed the published guidance. Basis is now generally the aggregate premiums paid, without reduction for cost-of-insurance charges.
Two practical consequences. First, the taxable gain on a settlement of an older, heavily front-loaded policy can be materially smaller than pre-2020 planning materials suggest. Second, basis reconstruction becomes the work: on a policy in force for twenty or thirty years, the client rarely has a complete premium history. Request a carrier-produced policy history and reconcile it against whatever records exist. Verify current-year application of these rules for the 2026 filing season before relying on them.
The Three-Tier Stack, Applied
Tier one: proceeds up to basis are recovered tax-free as a return of premium. Tier two: proceeds exceeding basis but not exceeding cash surrender value are ordinary income — the same character the client would have realized on a surrender, which is the point of the alignment. Tier three: proceeds above cash surrender value are generally long-term capital gain, assuming the holding period is satisfied, because that increment reflects the value of the contract as property rather than inside build-up.
Adjustments that change the arithmetic: outstanding policy loans are treated as proceeds and can turn an apparently modest gain into a large one; prior partial surrenders or withdrawals reduce basis; and dividends taken in cash on a participating whole life contract have their own history. Where the contract is a modified endowment contract, distributions carry different ordering rules than the sale computation, so confirm MEC status before advising on alternatives. Texas imposes no individual income tax, so the entire analysis is federal.
Section 101(g): When Proceeds May Be Income-Tax Free
IRC Section 101(g) treats amounts received on the sale or assignment of a policy by a terminally or chronically ill insured to a qualified viatical settlement provider as amounts paid by reason of the death of the insured — which is to say, generally excludable from income. Terminal illness generally requires a physician certification that the insured is reasonably expected to die within 24 months. Chronic illness has its own certification standard and additional restrictions on the use of proceeds.
The definitional requirements matter: the exclusion depends on the certification and on the counterparty qualifying under the statute and applicable state licensing. Do not assume the exclusion because the client is sick; get the certification in the file, confirm the provider’s status, and confirm the current statutory requirements for 2026 before signing a return position. Where the exclusion applies, it usually dominates every other planning consideration.
| Item | Pre-TCJA treatment (Rev. Rul. 2009-13) | Current treatment (Rev. Rul. 2020-05) |
|---|---|---|
| Basis on a policy sale | Premiums paid reduced by cost-of-insurance charges | Generally total premiums paid, no COI reduction |
| Return of premium tier | Smaller, because basis was reduced | Larger, because basis is not reduced |
| Ordinary income tier | Basis up to cash surrender value | Basis up to cash surrender value (unchanged) |
| Capital gain tier | Amount above cash surrender value | Amount above cash surrender value (unchanged) |
| Terminal or chronic illness sale | Sec. 101(g) exclusion if requirements met | Sec. 101(g) exclusion if requirements met |
| Information reporting | None specific to policy sales | IRC Sec. 6050Y reportable policy sale reporting |
Section 6050Y Reporting and What Your Client Will Receive
A reportable policy sale carries information reporting obligations: the acquirer reports the acquisition and the payments made, the issuer reports the seller’s investment in the contract, and the seller receives statements. The regime exists precisely because the IRS previously had no visibility into policy sales, and it means the transaction will be visible on the client’s account regardless of how the client characterizes it.
Two workflow implications for the practitioner. First, tell the client to expect the information returns and to forward them rather than filing them in a drawer. Second, the issuer-reported basis figure is a starting point, not gospel — reconcile it against the carrier’s premium history, particularly on a policy that has changed ownership, been part of a 1035 exchange, or carried loans. Confirm current-year forms, deadlines and thresholds for 2026.
Texas Context: Chapter 1111A, STAR+PLUS and MERP
Life settlement contracts in Texas are governed by Chapter 1111A of the Texas Insurance Code, regulated by the Texas Department of Insurance. The chapter provides for licensing, disclosures to the owner, privacy protections for the insured’s information, and a rescission right after execution. Confirm current text and any 2026 amendments with TDI.
Where the client’s tax question is really a long-term-care question, two Texas facts frame it. Long-term services and supports run largely through STAR+PLUS managed long-term care, with a $2,000 individual countable-asset limit for long-term care Medicaid as of 2026 — confirm current standards with Texas Health and Human Services. And the Texas Medicaid Estate Recovery Program files claims against the probate estates of certain deceased recipients, which affects the after-tax, after-recovery value of proceeds that survive the client.
The Modeling Conversation to Have Before a Surrender
Clients and their advisors often arrive with the surrender already decided and ask you to compute the tax. The more useful engagement is a short comparison: cash surrender value net of tax, versus an indicative settlement range net of tax, versus the after-tax cost of continuing premiums for a policy that may still serve a purpose. Because the ordinary income tier is capped at cash surrender value, the incremental dollars a settlement produces above CSV are generally taxed at capital gain rates — which usually means the after-tax spread favors the settlement by more than the pre-tax spread does.
Note the ranges honestly: offers commonly land between 10% and 35% of face value, and the GAO’s 2010 study (GAO-10-775) found settlements averaging roughly four to eight times cash surrender value. Many policies get no offer at all. A free screening resolves the question in days rather than leaving it as an assumption inside your model.
How a Referral Works
With the client’s permission you send one document — the policy cover page. Nothing else, and no client tax data. The review is free, returns in one to two business days, and carries no obligation for you or the client. If the policy looks marketable, the client decides whether to proceed and signs the authorizations; the full file typically needs the cover page, a current in-force illustration, the latest carrier statement, and a HIPAA authorization signed by the insured.
A standard file runs roughly 60 to 120 days from submission to funding. The client remains in control at every step, including the statutory rescission window after any contract is executed. You keep your normal role: computing the consequence and advising on the return position, with independent legal counsel for the client where the transaction involves a trust, an entity, or a guardianship. Free policy review: (305) 209-7183.
Frequently Asked Questions
What is my client’s basis in a policy being sold?
Generally the aggregate premiums paid. Rev. Rul. 2020-05 conformed IRS guidance to the 2017 TCJA change, so basis is no longer reduced by cost-of-insurance charges as it was under Rev. Rul. 2009-13. Reconstruct the premium history from carrier records where the client’s own records are incomplete, and confirm current-year application for the 2026 filing season.
How is the gain characterized?
In three tiers: tax-free return of premium up to basis, ordinary income between basis and cash surrender value, and generally long-term capital gain above cash surrender value. Outstanding policy loans are treated as proceeds and can materially increase the gain, so pull the current loan balance before modeling.
When are proceeds income-tax free under Section 101(g)?
When a terminally or chronically ill insured sells or assigns the policy to a qualifying viatical settlement provider and the statutory certification requirements are met — generally a physician certification of a life expectancy of 24 months or less for terminal illness, with a separate standard and use restrictions for chronic illness. Get the certification in the file and confirm current requirements for 2026.
What does Section 6050Y mean for my client’s return?
A reportable policy sale generates information returns: the acquirer reports the acquisition and payments, the issuer reports investment in the contract, and the seller receives statements. Tell the client to forward those forms. Treat the issuer-reported basis as a starting point and reconcile it, especially where the policy carried loans or came through a 1035 exchange.
Does Texas tax the proceeds?
Texas imposes no individual income tax, so the analysis is federal only. That does not simplify the federal computation, and it does not affect information reporting obligations. Where the client is a nonresident or has multi-state exposure, confirm the sourcing rules in the other jurisdiction.
Is a modified endowment contract treated differently?
MEC status changes the ordering rules for distributions and loans, not the character analysis of an outright sale, but it frequently changes which alternative is best for the client. Confirm MEC status before comparing a settlement against a partial surrender or a loan strategy, because the pre-tax comparison can invert after tax.
What does the secondary market typically pay?
Offers commonly fall between about 10% and 35% of face value, and the GAO’s 2010 study (GAO-10-775) found settlements averaging roughly four to eight times cash surrender value. These are ranges from published sources, not projections for any particular policy, and many policies receive no offer at all.
How does a client get a policy priced?
With the client’s permission, send the policy cover page for a free review; a full indicative range usually needs the cover page, a current in-force illustration, the latest carrier statement, and a HIPAA authorization signed by the insured. Turnaround on the initial review is one to two business days, and a completed file typically funds in roughly 60 to 120 days.
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Related Reading
- Life Settlement Taxes Texas
- Cash Surrender Value Life Insurance
- Life Settlement Vs Surrender
- What Policies Qualify For Life Settlement
- Life Settlement Licensing Texas
- 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.