Arkansas imposes no state estate tax and no inheritance tax, which means the single most common original purpose for the irrevocable life insurance trusts sitting in your files — creating liquidity to pay a death tax — has, for the overwhelming majority of Arkansas families, ceased to exist. With the federal basic exclusion amount at $15 million per decedent for 2026 under the 2025 federal tax legislation and indexed thereafter, an Arkansas ILIT funded in 2004 against a $1.5 million exemption is now a trust holding an asset that solves a problem the client no longer has, while the trustee writes premium checks every year.
That is an estate planning problem, not a Medicaid problem, and it belongs to you rather than to the elder law bar. The questions it raises are valuation, trustee duty, income tax character on disposition, and whether the policy should be repositioned, converted, surrendered, sold, or simply kept because the family still values the death benefit.
This guide covers those questions for an Arkansas practice: what the state’s trust and insurance codes require, how to value an in-force contract defensibly, the federal income tax mechanics after the 2017 statutory changes, the transfer-for-value traps that catch intra-family repositioning, and a clean referral workflow. Pine Lake Life Solutions provides education and a free policy review only; we do not purchase policies, are not licensed in every state, and nothing here is legal, tax, or investment advice.
In This Article
- The Arkansas Trust Code and the Trustee Who Has Not Looked
- Valuing an In-Force Policy Defensibly
- Income Tax Character on Disposition, Post-2017
- Transfer-for-Value: The Trap in Intra-Family Repositioning
- When the Secondary Market Is Actually Relevant
- A Referral Workflow That Fits an Estate Planning Practice
- Frequently Asked Questions
The Arkansas Trust Code and the Trustee Who Has Not Looked
Arkansas adopted the Arkansas Trust Code, codified at Arkansas Code Annotated section 28-73-101 and following, based on the Uniform Trust Code. Together with the state’s prudent investor provisions, it imposes on a trustee the familiar duties of loyalty, prudent administration, impartiality among beneficiaries, and to keep beneficiaries reasonably informed. Verify the current text of the specific provision you intend to rely on; the code has been amended since enactment.
Apply those duties to a life insurance policy and the practical problem is obvious. A family trustee — typically the grantor’s adult child, serving without compensation and without counsel — receives an annual statement they do not read, pays a premium they do not question, and has no idea that the contract’s cost-of-insurance charges are consuming the account value on a schedule that will exhaust it at age 84. When the policy lapses, the beneficiaries lose the death benefit and the trustee learns for the first time that the contract had a secondary-market value the whole time.
The mitigation is a documented periodic review. Once a year, or at minimum every three years, the trustee should obtain a current in-force illustration run at both the current premium and the minimum premium required to carry the policy to maturity, compare the carrier’s internal alternatives, and record a decision. Where the trust instrument or an applicable statutory provision limits the trustee’s duty to investigate or diversify insurance holdings, that limitation should be identified in writing rather than assumed. See the mechanics of disposing of a trust-owned policy for the consent and authority questions that follow.
Where the trust is being terminated or decanted, the policy is an asset requiring valuation, and valuation is where estate planners most often understate what the family holds.
Valuing an In-Force Policy Defensibly
Estate planners default to interpolated terminal reserve plus unearned premium because that is the number the carrier will furnish on request. It is the right starting point for gift tax reporting under the safe harbor framework in Revenue Procedure 2005-25, which sets out how the Service will treat the value of a life insurance contract for certain transfer purposes, and it is what a Form 712 will typically reflect.
It is frequently not the fair market value of the contract in the real world. For an insured whose health has materially declined since issue, an arm’s-length buyer in the secondary market may pay several multiples of both cash surrender value and interpolated terminal reserve, because the buyer prices the contract on a life expectancy underwriting basis rather than on carrier reserve mechanics. That gap has three practical consequences in an Arkansas estate planning practice.
First, when a policy is transferred out of a trust to a beneficiary or between family entities, a reported value based solely on carrier-furnished reserve figures may understate the transfer for gift tax purposes if a materially higher market value is known or reasonably ascertainable. Second, when a client is deciding whether to surrender, the surrender value is not the ceiling on what the contract is worth. Third, in a settlement negotiation, a family that does not know the interpolated terminal reserve, the cash surrender value, and an independent read on market value is negotiating with one of three numbers.
Our explainer on policy fair market value sets out the distinctions in plain terms. Coordinate valuation questions with the client’s tax professional; the reporting position is theirs and yours jointly, not the settlement market’s.
Income Tax Character on Disposition, Post-2017
The rules changed materially in the 2017 federal tax act and a surprising number of planning memoranda still reflect the prior regime. Three points are load-bearing.
Basis is no longer reduced by cost of insurance. Revenue Ruling 2009-13 had required a seller to reduce basis by the cost-of-insurance charges consumed while the policy was held, which increased taxable gain on a sale. The 2017 act reversed that result by statute, retroactive to transactions after August 25, 2009. Basis is generally premiums paid, without the cost-of-insurance reduction.
The three-tier structure. On a sale, proceeds up to the owner’s basis are generally a recovery of capital and not taxable. Proceeds between basis and cash surrender value are generally ordinary income. Proceeds above cash surrender value are generally capital gain. Our page on tax basis in a policy sale works through examples, and Arkansas tax considerations covers the state overlay — Arkansas taxes individual income, so the ordinary-income tier carries a state cost even though the state imposes no estate or inheritance tax.
Reporting is now mandatory. The 2017 act added information reporting for reportable policy sales under Internal Revenue Code section 6050Y, implemented through Forms 1099-LS and 1099-SB. Your client will receive paper. The acquirer reports the payment; the issuer reports basis information. Tell the client to expect it so it does not arrive as a surprise the following February.
Where the insured is terminally or chronically ill, the analysis shifts entirely: amounts received under section 101(g), whether from an accelerated death benefit rider or from a qualifying viatical settlement with a licensed provider, are generally excluded from gross income subject to the statute’s conditions. Check illness status before running the sale analysis, because it can make the tax question moot.
| Valuation Measure | What It Reflects | Typical Use | Limitation |
|---|---|---|---|
| Cash surrender value | What the carrier pays to terminate | Floor for any disposition decision | Ignores impaired health entirely |
| Interpolated terminal reserve plus unearned premium | Carrier reserve mechanics | Gift and transfer reporting; Form 712 | Not a market price; see Rev. Proc. 2005-25 framework |
| Secondary market offer | Buyer pricing on life expectancy underwriting | Arm’s-length evidence of what the contract commands | Requires medical underwriting; 60 to 120 days |
| Net death benefit | Face amount less loans and accelerated payments | What beneficiaries actually receive | Only realized at death |
| Reduced paid-up death benefit | Coverage purchasable with existing cash value | Alternative that stops premiums without a sale | Smaller benefit; whole life contracts only |
Transfer-for-Value: The Trap in Intra-Family Repositioning
Estate planners reposition policies constantly — out of an ILIT, into a new trust, between spouses, from an entity to an owner. Internal Revenue Code section 101(a)(2) provides that where a policy is transferred for valuable consideration, the death benefit exclusion is generally limited to the consideration paid plus subsequent premiums, with exceptions for transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, to a corporation in which the insured is a shareholder or officer, and for carryover-basis transfers.
The 2017 act layered on the “reportable policy sale” concept in section 101(a)(3), which can cause the transfer-for-value rule to apply even to some transactions that would previously have qualified for an exception. This is the single most common technical error in policy repositioning, and it converts a tax-free death benefit into a largely taxable one.
Practical rule for an Arkansas file: before any policy changes hands for consideration, have the client’s tax professional confirm that either an exception applies or the consequences are understood and accepted. Do not rely on the general proposition that life insurance proceeds are tax-free. That proposition is true right up until it is not, and section 101(a)(2) is where it stops being true.
Note as well the three-year rule in section 2035: a transfer of a policy on the insured’s life within three years of death generally pulls the proceeds back into the gross estate. For an Arkansas client this rarely produces a federal tax at current exclusion levels, but it is still the right analysis to run, and it matters where portability elections or generation-skipping allocations depend on the composition of the gross estate.
When the Secondary Market Is Actually Relevant
Be honest with clients about screening. A life settlement is worth exploring in an estate planning file when four things are true at once: the insured is generally 65 or older, or materially impaired at any age; the face amount exceeds roughly $100,000; the contract will still exist at death — meaning permanent coverage or convertible term, not expiring term; and the family has concluded the death benefit is no longer needed or no longer affordable.
It is not relevant, and you should say so, when the insured is in strong health for their age, when the face amount is small, when the premium is comfortably affordable and the benefit still serves a purpose, or when the policy is a guaranteed universal life contract whose no-lapse guarantee is intact and inexpensive relative to the benefit. Those contracts frequently represent excellent value that a family would be foolish to trade.
Arkansas regulates life settlement and viatical settlement transactions within Title 23 of the Arkansas Code, the state’s insurance code, administered by the Arkansas Insurance Department. The framework follows the general NAIC pattern of provider and broker licensure, mandatory owner disclosures, an unconditional rescission period, and anti-fraud reporting. Verify current section numbers and amendments before citing a specific provision. See Arkansas licensing requirements and the Arkansas Insurance Department’s consumer functions.
Where the client’s file also involves long-term care funding, coordinate with the elder law side of the analysis rather than duplicating it. Arkansas administers Medicaid through the Department of Human Services, with home and community based long-term care services running principally through the ARChoices program; the individual resource limit remains $2,000 and life insurance above $1,500 of total face value is generally countable at its cash surrender value. Confirm current figures with the agency and see the Arkansas Medicaid limits page and our Arkansas elder law companion guide.
A Referral Workflow That Fits an Estate Planning Practice
Six steps, none of which require you to become a settlement specialist.
One. Add to your trust review checklist: for every irrevocable trust holding life insurance, request the current in-force illustration at current and minimum premium, the annual statement, and the rider schedule.
Two. Identify the projected lapse year. That single number tells you whether this is an urgent file or a monitoring file.
Three. Price the carrier’s internal alternatives in writing — face reduction, reduced paid-up, extended term, accelerated benefit availability. These cost nothing.
Four. If the family concludes the coverage is no longer wanted, obtain an independent read on secondary-market value before recommending surrender, so the trustee is choosing between two known numbers rather than one known number and an assumption.
Five. Run the income tax analysis with the client’s CPA before signing, including the three-tier character allocation, the Arkansas state income tax overlay, and any transfer-for-value exposure.
Six. Document the comparison, the beneficiary notice, and the decision. For a trustee, that memorandum is the difference between a defensible administration and a claim.
On compensation: Arkansas lawyers are governed by the Arkansas Rules of Professional Conduct, which restrict giving anything of value for recommending a lawyer’s services and require informed consent where compensation for the representation comes from a person other than the client. Treat any offer of a referral fee as a conflicts question and confirm current rule text and Arkansas Supreme Court or bar guidance before structuring anything. The clean posture is an uncompensated referral with written disclosure of every compensation flow.
A free policy review requires only the cover page, carries no fee and no obligation, and a policy with no market value gets that answer directly. Call (305) 209-7183 to have one looked at.
Frequently Asked Questions
Does Arkansas impose an estate or inheritance tax?
No. Arkansas imposes neither, which removes the original liquidity rationale from most older Arkansas ILITs. With the federal basic exclusion amount at $15 million per decedent for 2026 under the 2025 federal legislation and indexed thereafter, trusts funded against far lower exemptions now hold assets addressing a problem the family no longer has. Confirm current federal figures.
Is cash surrender value the right value to report on a policy transfer?
Usually not by itself. Gift and transfer reporting typically uses interpolated terminal reserve plus unearned premium, consistent with the safe harbor framework in Revenue Procedure 2005-25. Where a materially higher arm’s-length market value is known, the reporting position should be worked through with the client’s tax professional rather than defaulted to the carrier’s figure.
How is a settlement taxed after the 2017 changes?
Generally in three tiers: proceeds up to basis are a return of capital, proceeds between basis and cash surrender value are ordinary income, and proceeds above cash surrender value are capital gain. Basis is no longer reduced by cost of insurance following the 2017 statutory reversal of Revenue Ruling 2009-13, retroactive to sales after August 25, 2009.
What is the transfer-for-value risk in repositioning a policy?
Under IRC 101(a)(2), a transfer for valuable consideration can limit the death benefit exclusion to consideration paid plus subsequent premiums, with statutory exceptions. The 2017 act’s reportable policy sale rules in 101(a)(3) narrowed reliance on some exceptions. Confirm with the client’s tax professional before any policy changes hands for consideration.
What should an ILIT trustee do at a periodic review?
Obtain a current in-force illustration at both the current premium and the minimum premium to maturity, identify the projected lapse year, price the carrier’s internal alternatives in writing, obtain an outside read on market value if disposition is contemplated, notify beneficiaries, and record a written decision. That package is the trustee’s protection under the Arkansas Trust Code duties.
When should an estate planner not raise a settlement at all?
When the insured is in strong health for their age, when the face amount is under roughly $100,000, when the premium is affordable and the death benefit still serves a purpose, or when a guaranteed universal life contract’s no-lapse guarantee is intact and cheap relative to the benefit. Those contracts often represent value a family should keep.
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Related Reading
- Life Settlement Licensing Arkansas
- Arkansas Medicaid Asset Income Limits
- Arkansas Insurance Department Consumer Help
- Life Settlement Taxes Arkansas
- Elder Law Attorney Life Settlement Guide Arkansas
- Trust Officer Life Settlement Guide Arkansas
- Sell Ilit Trust Owned Policy
- What Is Policy Fair Market Value
- Life Settlement Tax Basis Explained
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.