Taxes on Life Settlement Proceeds in Maryland (2026)

How the Federal Rules Split Your Proceeds

The framework, settled by the Tax Cuts and Jobs Act and clarified in IRS Revenue Ruling 2020-05, treats a life settlement as the sale of an asset with three slices:

1. Basis comes back tax-free. Your basis is generally the total premiums you paid into the policy. That portion of the sale price is simply your capital returning.
2. The surrender-equivalent gain is ordinary income. The slice between your basis and the policy’s cash surrender value is taxed as ordinary income — mirroring what a surrender would have produced.
3. The market premium is capital gain. Everything the buyer pays above the cash surrender value is capital gain — long-term, at favorable federal rates, if you held the policy more than a year (which sellers almost always have).

One post-2017 improvement worth knowing: sellers no longer reduce basis by cost-of-insurance charges, an old IRS position that inflated taxable gains before the TCJA reversed it. And note the contrast with a simple surrender, where the entire gain above basis is ordinary income with no capital-gain layer at all — part of why the after-tax comparison in life settlement vs. surrender often favors the settlement when the gross offer is higher anyway.

Maryland’s Two-Part State Tax: State Rate Plus County Rate

Maryland taxes individual income at graduated rates reaching approximately 5.75% at the top as of 2026 — and then nearly every Maryland county (plus Baltimore City) levies its own local income tax on the same base, generally in the range of about 2.25% to 3.2% (confirm current state and county rates with the Comptroller of Maryland, as counties adjust their rates periodically).

What this means for a settlement seller:

• Your combined marginal rate depends on your county. A high-bracket seller in a 3.2% county faces roughly 8.95% combined state-and-local on the taxable gain; a seller in a lower-rate county pays less.
• No capital-gains discount. Maryland generally taxes capital gains as ordinary income, so the capital-gain layer that enjoys reduced federal rates is taxed at your full combined Maryland rate.
• Nonresidents: Maryland applies a special nonresident rate in place of the county tax for those who owe Maryland tax without a county of residence — relevant if you recently moved.

The county layer is easy to forget in back-of-envelope math and can shift the after-tax result by thousands of dollars on a large gain — include it.

A Worked Example: Silver Spring Seller, $120,000 Sale

A 74-year-old in Silver Spring sells a $300,000 universal life policy for $120,000 in 2026. Premiums paid over the years (basis): $70,000. Cash surrender value at sale: $88,000.

• Tax-free layer: the first $70,000 — return of basis.
• Ordinary-income layer: $18,000 — the gap between basis ($70,000) and CSV ($88,000). Taxed at his federal ordinary bracket plus combined Maryland state and county rates.
• Capital-gain layer: $32,000 — sale price ($120,000) minus CSV ($88,000). Taxed federally at long-term capital-gain rates, but at full ordinary rates for Maryland purposes.

Of $120,000 received, $50,000 is taxable. If his combined Maryland state-plus-county marginal rate were, say, 8% (illustrative — actual depends on bracket and county), the Maryland layer alone would run roughly $4,000, on top of the federal bill. Had he instead surrendered for $88,000, the $18,000 gain would all be ordinary income and he would have collected $32,000 less in gross proceeds. The example is a skeleton — your basis records, bracket, county, and offer will move every number, which is why a CPA belongs in the loop before closing.

The Viatical Exception: When the Proceeds Are Tax-Free

Federal law treats a viatical settlement — the sale of a policy insuring someone who is terminally ill — like an early payment of the death benefit. Under IRC Section 101(g), when a physician certifies a life expectancy of 24 months or less and the buyer is an appropriately licensed viatical settlement provider, the proceeds are generally excluded from federal income tax entirely. Chronically ill insureds can also qualify when proceeds go toward qualified long-term care costs, under additional conditions.

Because Maryland’s income tax calculation begins with federal adjusted gross income, amounts excluded federally generally never enter the Maryland return either — no state tax, no county tax. For families facing a terminal diagnosis and stacking medical bills, this exclusion can make a viatical sale one of the most tax-efficient liquidity events available. The certification and licensing requirements are strict and fact-specific, so have a tax professional confirm the exclusion applies before relying on it.

Layer of Proceeds (2026)	Federal Treatment	Maryland Treatment
Up to premium basis	Tax-free return of capital	Tax-free
Basis up to cash surrender value	Ordinary income	State rate up to ~5.75% + county tax ~2.25%–3.2% (2026 — verify)
Above cash surrender value	Long-term capital gain (reduced federal rates)	Taxed as ordinary income — no Maryland capital-gains preference
Viatical settlement (terminal illness, LE under 24 months)	Generally excluded under IRC Sec. 101(g)	Generally excluded — Maryland starts from federal AGI
Reporting	1099-LS (buyer) and 1099-SB (carrier)	Flows to Maryland Form 502

Lump-Sum Side Effects: Brackets, IRMAA, and Timing

A settlement usually lands as a single-year lump sum, and the bunching has knock-on effects beyond the tax tables:

• Bracket push. A $50,000 taxable gain stacked on normal retirement income can climb into higher federal and Maryland brackets for that one year.
• Medicare IRMAA. Medicare premium surcharges are based on income from two years prior — a 2026 gain can raise 2028 Part B and Part D premiums. Sellers near IRMAA thresholds should model this.
• Taxability of Social Security. Extra income can pull more of your Social Security benefits into taxation for the year.
• Estimated payments. A large untaxed-at-source gain may require federal and Maryland estimated tax payments to avoid underpayment penalties.

Mitigation is mostly about timing and offsets — choosing the sale year deliberately, harvesting capital losses, bunching charitable deductions. None of it works retroactively, so the tax conversation should precede the settlement contract, not follow the 1099s.

The Paper Trail: 1099-LS, 1099-SB, and Your Maryland Return

Congress built reporting rules specifically for this market. After a sale, expect:

• Form 1099-LS from the settlement buyer, reporting the amount paid for your policy;
• Form 1099-SB from your insurance carrier, reporting your investment in the contract — the basis figure your preparer needs to split the layers correctly;
• Maryland Form 502 — the taxable layers flow from your federal return into your Maryland resident return, where the state and county rates apply.

Keep independent records of premiums paid, especially on older policies. Carrier-reported basis is usually accurate but can miss dividends applied, partial withdrawals, or ownership changes from decades past — and basis is the number that decides how much of your money returns tax-free. If a viatical exclusion applies, the physician certification is the document to preserve. Your policy’s cash surrender value statement at the time of sale matters too, since it marks the boundary between the ordinary-income and capital-gain layers.

Taxes Meet Medicaid: Sequencing for Maryland Families

Many Maryland settlements happen because a family needs to fund long-term care, which puts two rulebooks in play at once. The essentials:

• Settlement proceeds are countable assets for Maryland Medicaid long-term-care purposes until spent down on allowable costs;
• Selling at fair market value is not a gift — it does not trigger the five-year lookback penalty that giving the policy away would;
• The taxable gain arrives in the sale year, so the tax bill itself becomes part of the spend-down math — money set aside for April is money not available for care.

The clean sequence: value the policy, model the after-tax proceeds with a CPA, plan the spend-down with an elder law attorney, then sell and pay for care privately until eligibility. Our companion guide to Maryland’s Medicaid asset and income limits covers the 2026 numbers, and how it works lays out the 60-120 day settlement timeline to build into the calendar.

Know Your Numbers Before You Owe Them

Four figures determine what a Maryland seller actually keeps: total premiums paid, cash surrender value, the gross offer, and your combined federal-state-county marginal rates. Pine Lake Life Solutions can help with the first step — a free policy review that tells you whether your policy has secondary-market potential and what a realistic range looks like. Send the policy’s cover page or call (305) 209-7183; there is no fee and no obligation, and “keep the policy” is an answer we give when it is the right one.

We do not provide tax advice — bring your CPA the numbers before signing anything. For the regulatory protections wrapped around a Maryland sale (licensing, disclosures, and your rescission window), see Maryland’s life settlement licensing guide.

---

Frequently Asked Questions

How are life settlement proceeds taxed in Maryland?

In three layers under 2026 federal rules: proceeds up to your total premiums paid are tax-free, the gain up to the cash surrender value is ordinary income, and the amount above that is capital gain. Maryland then taxes the taxable layers at its state rate (top around 5.75%) plus your county’s local income tax, roughly 2.25% to 3.2% depending on where you live.

Does my Maryland county really tax my life settlement gain?

Yes. Maryland counties and Baltimore City levy a local income tax on the same income base as the state tax, so your combined rate on the settlement gain depends on your address — potentially approaching 9% combined at the top in the highest-rate counties. Confirm your county’s current rate with the Comptroller of Maryland before estimating your after-tax proceeds.

Are viatical settlements taxable in Maryland?

Generally no. When the insured is certified terminally ill with a life expectancy of 24 months or less and the buyer is properly licensed, the proceeds are excluded from federal income under IRC Section 101(g) — and since Maryland’s return starts from federal AGI, the exclusion carries through to state and county tax as well. The certification requirements are strict, so verify with a tax professional.

Does Maryland give a lower rate for the capital-gain portion?

No. Maryland generally taxes capital gains as ordinary income at the same state and county rates. The capital-gain layer of your settlement still benefits federally — long-term capital-gain rates are usually well below ordinary rates — but at the Maryland level, all taxable layers are treated alike.

Is it more tax-efficient to sell my policy than surrender it in Maryland?

Often, when the offer is meaningfully higher. Surrender gain above basis is entirely ordinary income. In a settlement, everything above the cash surrender value is capital gain federally, taxed at lower rates. Since qualifying policies historically sold for roughly 4 to 8 times surrender value in the GAO’s market study, the settlement frequently wins both pre-tax and after-tax — but your basis and brackets decide, so run the numbers.

Can a settlement raise my Medicare premiums?

It can, indirectly. Medicare’s IRMAA surcharges are based on your income from two years earlier, so a large 2026 gain can raise your Part B and Part D premiums in 2028. Sellers near the IRMAA thresholds should model the effect and consider timing before closing. It also may increase how much of your Social Security is taxable in the sale year.

What tax documents should I expect after selling my policy?

Form 1099-LS from the buyer showing what you were paid, and Form 1099-SB from your insurance carrier showing your basis in the contract. Your preparer uses both to divide the proceeds into tax-free, ordinary, and capital-gain layers on the federal return, which then flows into Maryland Form 502. Keep your own premium records in case the carrier’s basis needs correcting.

Do settlement proceeds count against Maryland Medicaid limits?

Yes, until spent down — the cash is a countable asset. But because a life settlement is a fair-market-value sale rather than a gift, it does not trigger the five-year lookback penalty. Families commonly sell, pay for care privately with the proceeds (setting aside the tax bill), and apply for Medicaid once assets fall within limits, coordinated by an elder law attorney.

Related Reading

• Life Settlement Vs Surrender
• Cash Surrender Value Life Insurance
• Life Settlement Licensing Maryland
• Maryland Medicaid Asset Income Limits
• How It Works Policy Options
• 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.