The richest source of settlement candidates in an Arizona estate planning practice is the ILIT that was built to pay an estate tax the client will no longer owe. Those trusts are still paying premiums, still filing Crummey notices, and still holding a policy whose original purpose evaporated when the federal exemption moved.
Federal exemption levels rose substantially for 2026 under legislation enacted in 2025 — verify the exact indexed figure before advising, because the planning conclusion depends on it. Arizona compounds the effect: the state imposes no estate tax and no inheritance tax, so for a large share of Arizona clients the liquidity rationale for a legacy ILIT is now entirely gone rather than merely reduced.
Send us a redacted policy cover page. With appropriate authority and consents, one page produces a free preliminary read you can attach to a trust review memo. Typical turnaround is one to two business days, with no obligation. Call (305) 209-7183.
In This Article
- Auditing the Book for Over-Insured Trusts
- The Trustee’s Duty to Monitor Under Arizona Law
- Tax Mechanics the Drafting Attorney Should Know
- Transfer-for-Value and the Traps Around It
- Arizona’s Statutory Frame
- Where This Intersects With Long-Term Care Planning
- How a Referral Works
- Frequently Asked Questions
Auditing the Book for Over-Insured Trusts
The screen is mechanical. Pull ILITs formed when the federal exemption was materially lower, where the insured is now roughly 70 or older, the face amount is $100,000 or more, and the coverage is permanent, guaranteed universal life, or convertible term. Then ask the question the original engagement never had to ask: what is this death benefit for now?
Where the answer is estate tax liquidity and the estate no longer faces a federal estate tax, the policy has become an expense without a purpose. It may still serve income replacement, business continuity, equalization among children, or special-needs funding — all legitimate reasons to keep it. What is not legitimate is continuing to pay premiums because nobody re-examined the premise.
The Trustee’s Duty to Monitor Under Arizona Law
Arizona’s Trust Code sits in Title 14 of the Arizona Revised Statutes and incorporates prudent investor principles at A.R.S. Section 14-10901 and following. Under that framework a trustee has an affirmative duty to monitor and manage trust assets, not merely to receive gifts and remit premiums. A life insurance policy is a trust asset like any other.
The concrete exposure is surrender without pricing. If a trustee surrenders a policy for cash value when the secondary market would have paid materially more, the beneficiaries have a straightforward complaint and the trustee has no record to answer it. A market-tested indication in the file resolves that in either direction — including when it confirms surrender was the better outcome. Verify the current statutory citations with counsel before relying on them in a memo.
Tax Mechanics the Drafting Attorney Should Know
Three rules cover most of it. Gain up to the excess of cash surrender value over basis is generally ordinary income. Gain above that amount is generally capital gain. And a reportable policy sale triggers IRC Section 6050Y information reporting, which means Forms 1099-LS and 1099-SB will circulate among the buyer, the issuer, and the seller.
Basis is friendlier than practitioners who learned the old rules assume. Revenue Ruling 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change eliminating the cost-of-insurance basis reduction, so a seller’s basis is generally total premiums paid. That is a material improvement over the treatment under Revenue Ruling 2009-13. Arizona applies a flat individual income tax rate at the state level as of 2026 — verify the current rate and conformity date — which simplifies but does not eliminate the state-side modeling. See Arizona life settlement tax treatment.
| Tax question | General treatment | Authority to check |
|---|---|---|
| Seller’s basis in the policy | Generally total premiums paid; no cost-of-insurance reduction | Rev. Rul. 2020-05, conforming to the 2017 TCJA change |
| Gain up to cash surrender value over basis | Generally ordinary income | Longstanding IRS position; confirm with tax counsel |
| Gain above cash surrender value | Generally capital gain | Rev. Rul. 2020-05 and prior guidance |
| Information reporting on a reportable policy sale | Forms 1099-LS and 1099-SB circulate among buyer, issuer, seller | IRC Sec. 6050Y |
| Terminally ill seller | Proceeds may be excluded from income when certification requirements are met | IRC Sec. 101(g) |
| Arizona state income tax on gain | Flat individual rate as of 2026; verify rate and conformity date | Arizona Department of Revenue |
Transfer-for-Value and the Traps Around It
The transfer-for-value rule can convert an otherwise tax-free death benefit into taxable income in the recipient’s hands, and the reportable policy sale rules interact with it. Institutional buyers in this market structure around those provisions as a matter of course, but the analysis belongs to the client’s tax counsel, not to the buyer.
Two related drafting points. First, if a trust sells a policy, confirm that the trustee has express or statutory authority to sell trust assets of that character and that any required beneficiary notice is given. Second, if a policy is being moved between related parties before a sale, run the transfer-for-value analysis first, because the sequence matters more than the destination.
Arizona’s Statutory Frame
Settlements in Arizona are governed by the viatical settlement provisions of A.R.S. Title 20 and regulated by the Arizona Department of Insurance and Financial Institutions. DIFI absorbed the former Arizona Department of Insurance, so older statutory and regulatory references point to the same function.
Diligence for the file is short: confirm provider licensure through DIFI, and confirm independent escrow with release conditioned on the carrier’s confirmation of the ownership change. Arizona’s status as a community property state also matters when an individually owned policy is being sold, since characterization affects consent and the treatment of proceeds between spouses.
Where This Intersects With Long-Term Care Planning
Many estate planning clients eventually become long-term care planning clients, and the policy question arrives again in a different posture. The Arizona Long Term Care System applies a $2,000 individual countable-asset limit as of 2026, and ALTCS uniquely requires a separate Preadmission Screening functional assessment alongside financial eligibility, delivered through managed care program contractors.
For an estate planner, the practical takeaway is sequencing. A policy examined during a routine trust review, when there is time to shop it properly, produces a better outcome than the same policy examined under application pressure. See Arizona Medicaid asset and income limits.
How a Referral Works
Send one document with appropriate authority and client consent: the policy cover page. Carrier, product type, face amount, and issue date are enough for a preliminary read on marketability. There is no fee, no engagement, and no obligation for you, the client, or the trust.
The first read typically returns in one to two business days. An indicative range requires three additional items: a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization. A standard file runs roughly 60 to 120 days through funding, so build that into any trust review timeline or beneficiary communication.
The client or trustee remains in control at every step and can stop before closing. Call (305) 209-7183. Pine Lake works with policies of $100,000 or more in death benefit and typically produces more than cash surrender value.
This page is educational only and is not legal, tax, or investment advice for you or your client. Independent counsel should review any transaction before it is executed.
Frequently Asked Questions
Why are ILITs the best source of settlement candidates?
Because many were funded solely to pay an estate tax the client will no longer owe at 2026 federal exemption levels, and Arizona imposes no state estate or inheritance tax. The premiums continue, the purpose does not. Verify the exact 2026 exemption figure before advising.
Does an Arizona trustee have to consider the secondary market?
Arizona’s Trust Code incorporates prudent investor principles at A.R.S. Section 14-10901 and following, imposing a duty to monitor and manage trust assets. Surrendering a policy without pricing it is the exposure most commonly identified. Verify current citations with counsel.
How is a policy sale taxed?
Generally, gain up to the excess of cash surrender value over basis is ordinary income and gain above that is capital gain. Under Rev. Rul. 2020-05, basis is generally total premiums paid without a cost-of-insurance reduction. Confirm with the client’s tax professional.
What is a reportable policy sale?
A sale that triggers IRC Section 6050Y information reporting, producing Forms 1099-LS and 1099-SB among the buyer, the issuer, and the seller. Clients receive forms and will ask what to do with them, so the reporting should be anticipated in the planning.
Does the transfer-for-value rule apply?
It can, and it interacts with the reportable policy sale rules. Institutional buyers structure around it routinely, but the analysis belongs to the client’s tax counsel. Run it before moving a policy between related parties, because sequence matters.
Which Arizona agency oversees these transactions?
The Arizona Department of Insurance and Financial Institutions, under the viatical settlement provisions of A.R.S. Title 20. DIFI absorbed the former Arizona Department of Insurance, so older references point to the same regulatory function.
How do I get a preliminary read on a trust-owned policy?
Send the policy cover page with appropriate authority and consents. The review is free and typically returns in one to two business days. An indicative range then requires a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization.
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Related Reading
- Cash Surrender Value Life Insurance
- What Policies Qualify For Life Settlement
- Life Settlement Taxes Arizona
- Life Settlement Licensing Arizona
- Arizona 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.