The CPA is usually the first professional to see a policy heading for lapse, because the premium shows up as a recurring outflow long before anyone calls it a planning problem. It appears on a retiree’s cash-flow review, on a Form 1041 for a trust paying premiums out of principal, or as a line item a client circles and asks whether they still need.
The tax picture improved materially in recent years. Rev. Rul. 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change: a seller’s basis is no longer reduced by cost-of-insurance charges, so basis is generally total premiums paid. That is a real improvement over the old Rev. Rul. 2009-13 treatment and it changes the arithmetic on cases that used to look unattractive after tax.
Send us a redacted policy cover page. With your client’s permission, one page starts a free review. Initial read is typically one to two business days, with no obligation for you or your client. Call (305) 209-7183.
In This Article
Where the Premium Shows Up on Your Desk
Three recurring sightings. First, a personal cash-flow review for a client in their seventies where a five-figure annual premium is competing with care costs. Second, a fiduciary return for an irrevocable trust whose only meaningful activity is paying premiums out of principal, with beneficiaries who have started asking why. Third, a business return where a policy originally bought for a buy-sell or key-person purpose has outlived the arrangement it funded.
In all three the client’s default assumption is that the only alternatives are keep paying or surrender. That assumption is what makes the CPA’s question valuable: the policy may have a market value that exceeds the carrier’s surrender figure, and finding out costs nothing.
Basis After Rev. Rul. 2020-05
Under Rev. Rul. 2009-13 the IRS took the position that a seller’s basis was reduced by the cost-of-insurance component of premiums paid, which depressed basis and inflated gain. The 2017 Tax Cuts and Jobs Act changed the statutory treatment, and Rev. Rul. 2020-05 conformed the guidance. The practical result is that basis is generally total premiums paid, without the cost-of-insurance haircut.
Documenting that number is the work. Carriers do not always produce a clean premium history on request, and clients rarely keep thirty years of statements. Start the request early, because the basis figure drives the ordinary/capital split and the client will want an estimate before deciding whether to sell.
The Three-Layer Characterization
For a life settlement the federal analysis runs in layers. Proceeds up to basis are a return of capital. Gain from basis up to the policy’s cash surrender value is ordinary income, reflecting the inside buildup. Gain above the cash surrender value is generally capital gain, long-term where the holding period is met.
A viatical settlement is different: where the insured is certified terminally ill under IRC Sec. 101(g), proceeds are generally excluded from income entirely, and chronically ill certifications have their own rules. Establishing which regime applies is a threshold determination, not a footnote, and it can change the after-tax result dramatically.
IRC Sec. 6050Y: The Forms Your Client Will Bring You
A reportable policy sale triggers information reporting on three sides. The buyer files Form 1099-LS reporting the payment to the seller. The issuing carrier files Form 1099-SB reporting the seller’s investment in the contract and the policy’s surrender amount. The seller receives copies. Clients who were not warned tend to arrive at your office alarmed by mail they did not expect.
Two practical notes. The carrier’s stated investment in the contract on the 1099-SB may not match your computed basis, and reconciling the difference is a normal part of the engagement. And the timing of the forms relative to the closing date matters for which return year the transaction lands in, so pin the funding date down.
| Proceeds layer | Federal character | Practical note for the return |
|---|---|---|
| Amount up to basis | Return of capital, not income | Basis is generally total premiums paid after Rev. Rul. 2020-05 |
| Basis up to cash surrender value | Ordinary income | Reflects inside buildup; needs the carrier’s stated CSV |
| Amount above cash surrender value | Generally capital gain | Long-term where the holding period is satisfied |
| Viatical proceeds, terminally ill insured | Generally excluded under IRC Sec. 101(g) | Requires a qualifying physician certification |
| Surrender to the carrier instead of a sale | Ordinary income above basis | No capital gain layer available |
| Virginia Form 760 treatment | Flows from federal AGI | Top individual rate 5.75% as of 2026; confirm current rates |
The Virginia Return
Virginia’s individual income tax computation starts from federal adjusted gross income, so the federal characterization generally carries through to Form 760 rather than being recomputed under separate state rules. Virginia’s top individual rate is 5.75% as of 2026 — confirm current rates and any legislative changes before relying on a projection. Virginia does not currently impose a separate state estate tax, which simplifies the analysis on trust-owned cases.
Where the client is a nonresident or a part-year resident — common with the Northern Virginia and DC-metro population — sourcing and credit-for-taxes-paid questions apply as usual. Our overview of Virginia life settlement tax treatment covers the framework in more detail.
When the Client Is Heading Toward Medicaid
If the client is on a path toward long-term care Medicaid, the tax analysis and the eligibility analysis have to be run together. Virginia’s Cardinal Care and CCC Plus programs, administered by the Department of Medical Assistance Services, apply a $2,000 individual countable-asset limit as of 2026. Proceeds are cash in the month received, so timing and deployment matter enormously.
A documented sale at fair market value should not create a transfer penalty under the 60-month lookback, unlike a gift of the policy to a child — a move families sometimes make on their own before anyone advises them. Coordinate with the client’s elder law counsel; the eligibility judgment is theirs. See Virginia Medicaid asset and income limits for current thresholds.
Professional Standards and Scope
Virginia CPAs are licensed by the Virginia Board of Accountancy and operate under the AICPA Code of Professional Conduct, including the Statements on Standards for Tax Services where tax advice is being rendered. Raising the existence of a secondary market is asset identification and is squarely within a cash-flow or planning engagement. Recommending a specific transaction is a different act with different documentation requirements, and any compensation arrangement would implicate independence and disclosure rules — verify current Board and AICPA guidance for 2026.
The conservative and common approach: tell the client the market exists, tell them a valuation is free, compute the after-tax comparison once numbers exist, and let the client decide with independent counsel. That keeps you in the role clients hire you for.
How a Referral Works
You send the policy cover page and nothing else, with your client’s permission. That page shows the carrier, product type, face amount, and issue date — enough for a preliminary read. There is no fee, no engagement, and no obligation on either side.
The first read is typically one to two business days. If the policy looks viable, three more documents produce an indicative range: a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization. From complete documentation through funding, a standard file usually runs about 60 to 120 days — which matters if the client is trying to land the transaction in a particular tax year.
Your client stays in control throughout. They decide whether to proceed, they can stop at any point before closing, and any offer can be reviewed by you and by independent counsel before acceptance. 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 for you or your client. Pine Lake Life Solutions does not provide tax or legal counsel; independent professionals should review any transaction before it is executed.
Frequently Asked Questions
What is the seller’s basis in a life insurance policy today?
After the 2017 Tax Cuts and Jobs Act change and Rev. Rul. 2020-05, basis is generally total premiums paid, without reduction for cost-of-insurance charges. That reverses the less favorable position taken in Rev. Rul. 2009-13 and improves the after-tax math on many older policies.
How is the gain split between ordinary income and capital gain?
Gain from basis up to the policy’s cash surrender value is ordinary income. Gain above the cash surrender value is generally capital gain. You need the carrier’s stated cash surrender value as of the sale date to run the split accurately.
What forms will the client receive?
In a reportable policy sale, the buyer files Form 1099-LS and the issuing carrier files Form 1099-SB under IRC Sec. 6050Y, with copies to the seller. The 1099-SB reports the carrier’s figure for investment in the contract, which may differ from your computed basis and will need reconciling.
Is a viatical settlement taxed differently?
Yes. Where the insured is certified terminally ill under IRC Sec. 101(g), proceeds are generally excluded from gross income. Chronically ill certifications have separate requirements. Determining which regime applies should happen before the transaction, not at filing.
How does Virginia tax the proceeds?
Virginia’s individual income tax starts from federal adjusted gross income, so the federal characterization generally carries through to Form 760. The top individual rate is 5.75% as of 2026; confirm current rates and any legislative changes before relying on a projection.
Does a sale create a Medicaid transfer penalty?
A sale for fair market value is not an uncompensated transfer and should not trigger the 60-month lookback penalty, unlike gifting the policy to a family member. Documentation of an arm’s-length, market-tested sale is what supports that position. Confirm treatment with the client’s elder law counsel and DMAS.
Can I get an estimate of proceeds before advising the client?
Yes. A free review starting from the policy cover page produces a preliminary read, usually within one to two business days, and a fuller indicative range once the in-force illustration, carrier statement, and HIPAA authorization are supplied. There is no cost or obligation.
Should the transaction be timed to a tax year?
Often, yes. A standard file runs about 60 to 120 days from complete documentation through funding, so a client hoping to recognize gain in a particular year needs to start early. Income recognition follows the funding date, not the offer date.
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Related Reading
- Life Settlement Taxes Virginia
- Cash Surrender Value Life Insurance
- Life Settlement Vs Surrender
- Virginia 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.