Get the physician certification in writing first, and confirm the buyer is a licensed viatical settlement provider in the insured’s state before signing anything — those two documents are what convert a taxable policy sale into proceeds excluded from gross income under Internal Revenue Code section 101(g), and neither can be added after closing. Selling the same policy to the same amount of money without them produces a fully taxable transaction.
The exclusion came from the Health Insurance Portability and Accountability Act of 1996, which added section 101(g) to treat qualifying viatical payments as if they had been paid by reason of the insured’s death. Death benefits are generally excluded from income under section 101(a); section 101(g) extends that treatment forward in time to a person who is terminally or chronically ill and needs the money now.
The two categories are not treated the same. For a terminally ill insured the exclusion is broad and does not depend on what the money is spent on. For a chronically ill insured it is narrower: proceeds generally must be used for qualified long-term care services not compensated by insurance, and per diem style payments are subject to a statutory daily cap. Knowing which category applies determines everything downstream.
In This Article
The Terminal Illness Test, Precisely
Section 101(g)(4)(A) defines a terminally ill individual as one who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months of the date of certification.
Four operational points follow from that language. The certification must come from a physician, not a nurse practitioner or a case manager. It must be dated, because the 24-month period runs from the certification date. It must state the expectation of death within that window, not merely describe a serious diagnosis. And it should be retained with your tax records, because it is the substantiation for the exclusion.
Note what the statute does not require. It does not require hospice enrollment, though hospice election in Medicare requires its own physician certification of a prognosis of six months or less and typically makes the section 101(g) certification straightforward to obtain. It does not require that the insured actually die within 24 months; the test is the reasonable medical expectation at the time of certification. And it does not limit how the proceeds are spent — a terminally ill insured can use the money for anything.
The exclusion for a terminally ill insured applies to amounts received under a life insurance contract on that insured’s life, whether paid by the carrier as an accelerated death benefit or paid by a viatical settlement provider on a sale or assignment of the policy. Both routes are worth pricing; see accelerated death benefit compared with a viatical settlement.
The Chronic Illness Test and Its Limits
Section 101(g)(4)(B) borrows the chronically ill definition from section 7702B(c)(2). An individual qualifies if a licensed health care practitioner has certified, within the preceding twelve months, that the person either is unable to perform at least two activities of daily living without substantial assistance for an expected period of at least 90 days, or requires substantial supervision to protect against threats to health and safety due to severe cognitive impairment.
The six activities of daily living named in the statute are eating, toileting, transferring, bathing, dressing, and continence. Two of six is the threshold, the certification must be recent, and the 90-day expectation is part of the test.
Then come the limits that do not apply to terminal cases. Under section 101(g)(3), the exclusion for a chronically ill insured generally applies only to amounts used for qualified long-term care services not compensated by insurance or otherwise, and the payments are subject to the per diem limitation in section 7702B(d). That daily cap is indexed annually; it was $420 per day for 2025, and the current year’s figure should be confirmed against the IRS inflation adjustment revenue procedure rather than assumed.
The practical consequence is bookkeeping. A chronically ill insured relying on this exclusion needs to track care expenses and what insurance reimbursed. That recordkeeping requirement is the single most common reason a chronic-illness exclusion partially fails on audit, and it is entirely avoidable with a spreadsheet and receipts.
The Buyer Requirement People Miss
Section 101(g)(2) does not exclude proceeds from any buyer. It applies to amounts received on the sale or assignment of the policy to a viatical settlement provider, and section 101(g)(2)(B) defines that term with precision.
A qualifying provider is one regularly engaged in the business of purchasing or taking assignment of life insurance contracts on the lives of insureds who are terminally or chronically ill, and that is licensed for such purposes in the state in which the insured resides. If the insured’s state does not require licensing, the statute provides an alternative: the buyer must meet the requirements of the NAIC Viatical Settlements Model Act regarding disclosure and, in the case of a chronically ill insured, the requirements of the NAIC Viatical Settlements Model Regulation regarding standards for evaluation of reasonable payments.
Three practical implications. First, verify the buyer’s license in the insured’s state of residence before closing, not after — the process is described in how to verify a provider’s license in your state. Second, a private sale to a family member, an investor group, or an unlicensed party does not qualify for section 101(g) treatment no matter how ill the insured is. Third, if the insured has moved recently, the relevant state is where they reside now, which can differ from where the policy was issued or where the family lives.
Keep documentation of the buyer’s license status with the certification and the closing package. Together they are the substantiation file.
| Condition | Certification Required | Exclusion Scope | Spending Restriction |
|---|---|---|---|
| Terminally ill, IRC 101(g)(4)(A) | Physician, death expected within 24 months | Generally full exclusion | None |
| Chronically ill, IRC 101(g)(4)(B) | Licensed health care practitioner within past 12 months | Limited exclusion | Qualified long-term care services, subject to per diem cap |
| Accelerated death benefit from the carrier | Same tests apply | Generally excluded | Same as above by category |
| Sale to an unlicensed buyer | Irrelevant | No 101(g) exclusion | Fully taxable three-tier treatment |
| Ordinary life settlement, no qualifying illness | None | None | Basis, ordinary income, capital gain tiers |
| Death benefit paid at death, IRC 101(a) | None | Generally excluded | None |
How the Numbers Compare
Consider a $400,000 universal life policy on an insured with a certified terminal prognosis. Total premiums paid are $74,000. Cash surrender value is $19,000.
Surrender: $19,000 in cash, no taxable gain because surrender value is below basis, coverage ends.
Accelerated death benefit rider, if the policy has one: carriers commonly advance a percentage of the death benefit, with terms that vary widely by contract, and a qualifying payment is generally excluded under section 101(g). No commission, no medical records release beyond what the carrier requires, and the remaining death benefit continues for beneficiaries. Read the rider schedule before doing anything else.
Viatical settlement: because the projected life expectancy is short, the discount to face value is smaller than in an ordinary life settlement. Proceeds paid by a licensed viatical settlement provider to a certified terminally ill insured are generally excluded from income entirely.
The contrast with an ordinary life settlement is stark. In a non-viatical sale the proceeds split into three tiers — tax-free return of basis, ordinary income up to cash surrender value, and long-term capital gain above it — as described in how life settlement proceeds are taxed. Section 101(g), when it applies, collapses all of that to zero at the federal level, and most states conform to the federal exclusion because they begin with federal adjusted gross income.
Every Alternative, Ranked for a Seriously Ill Insured
1. Accelerated death benefit rider on the existing policy. Check first, always. It is generally tax-favored under the same section, costs no commission, involves no third-party buyer, and can be arranged with the carrier in weeks. Its limitation is that carriers advance only part of the death benefit and terms vary widely.
2. Chronic illness or long-term care rider. Similar mechanism, triggered by ADL or cognitive impairment criteria rather than terminal prognosis. Also worth reading before any transaction.
3. Viatical settlement with a licensed provider. Produces the largest lump sum in most terminal cases and, with the certification and licensed buyer in place, is generally excluded from income. Requires a death benefit of roughly $100,000 or more.
4. Keep the policy and pay the premium from other resources. If family can carry the premium, the full death benefit passes to beneficiaries generally free of income tax under section 101(a). Frequently the highest-value option for the family as a whole.
5. Reduced paid-up or face reduction. Ends the premium while preserving a smaller death benefit. Sensible when cash flow rather than a lump sum is the problem.
6. Surrender. Fastest and simplest, and usually the smallest amount. Compare it against every option above before choosing it.
When Selling Is the Wrong Answer
Five situations, and they are common.
When the family needs the death benefit more than the cash. A $400,000 death benefit paid to a surviving spouse under section 101(a) is worth more than a discounted lump sum today if the premium can be carried. Do that arithmetic before anything else.
When public benefits are at stake. Proceeds are a countable resource for Supplemental Security Income and Medicaid in the month received, and federal law applies a 60-month look-back to transfers. A viatical settlement can be excluded from income and still cost eligibility. This sequencing belongs with an elder law attorney before the transaction, not after.
When the accelerated death benefit rider would do the job. If the rider advances enough to cover the immediate need, using it preserves the remaining death benefit for the family at no commission cost.
When the certification cannot be obtained. Without a physician’s certification meeting the statutory test, the sale is an ordinary taxable life settlement. That may still be the right decision, but it should be made with the correct tax expectation.
When the face amount is under roughly $100,000. Pine Lake works with policies of roughly $100,000 or more in death benefit; below that the market generally does not engage regardless of health.
If you want to know what applies to a specific policy, send the policy cover page and the rider schedule for a free, no-obligation review, or call (305) 209-7183. Pine Lake Life Solutions provides educational information only and does not provide legal, tax, or investment advice; the section 101(g) analysis should be confirmed by your own CPA or tax attorney before you rely on it.
Frequently Asked Questions
What makes viatical proceeds tax-free?
Internal Revenue Code section 101(g), added by the Health Insurance Portability and Accountability Act of 1996, treats qualifying payments as if paid by reason of the insured’s death. Three things must line up: a qualifying illness, the required certification, and a buyer that meets the statutory definition of a viatical settlement provider in the insured’s state.
How is terminal illness defined for this purpose?
A physician must certify that the insured has an illness or physical condition reasonably expected to result in death within 24 months of the certification date. The insured does not have to die within that window; the test is the reasonable medical expectation when the certification is made. Keep the dated certification with your tax records.
What counts as chronically ill?
A licensed health care practitioner must certify, within the preceding twelve months, that the insured cannot perform at least two of six activities of daily living without substantial assistance for an expected 90 days, or needs substantial supervision due to severe cognitive impairment. The six activities are eating, toileting, transferring, bathing, dressing, and continence.
Is the chronic illness exclusion unlimited?
No. It generally applies only to amounts used for qualified long-term care services not compensated by insurance, and per diem style payments are capped under section 7702B(d). That cap is indexed annually and was $420 per day for 2025. Track care expenses and reimbursements carefully, because substantiation is where these exclusions fail.
Does it matter who buys the policy?
Very much. The exclusion applies to sales or assignments to a viatical settlement provider as defined in section 101(g)(2)(B), meaning a buyer licensed in the insured’s state or, absent state licensing, one meeting the NAIC model requirements. A private sale to a relative or an unlicensed investor does not qualify, regardless of the insured’s condition.
Should I use my accelerated death benefit rider instead?
Check it first. A qualifying accelerated payment from the carrier is generally excluded under the same statute, involves no commission and no buyer, and preserves the remaining death benefit for beneficiaries. Carriers advance only a portion and terms vary widely by contract, so read the rider schedule before pursuing any sale.
Do states follow the federal exclusion?
Most do, because state income tax generally begins with federal adjusted gross income, so an amount excluded federally never enters the state calculation. A few states have their own rules. Confirm with your own CPA, particularly if you have recently changed residency or split the year between two states.
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Related Reading
- What Is A Viatical Settlement
- Viatical Settlement Tax Exclusion Explained
- Life Settlement Vs Viatical Settlement
- Terminal Illness Sell Policy
- What Is An Accelerated Death Benefit Rider
- Accelerated Death Benefit Vs Viatical
- Taxes On Life Settlement Proceeds
- Verify Provider License State
- Hospice Enrollment Viatical
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.