[Update] Major tax reductions for Life Settlements

/in , /by Morris Heins

[Update] Major tax reductions for Life Settlements

There may be Federal taxation when a cash value policy is surrendered for cash but not sold.

In 2009 the IRS issued Revenue Ruling 2009-13 which explained the taxation of cash value policies that were terminated and surrendered for cash. An example follows, and links to this Revenue Ruling is in the Addendum.

Example: Individual A

Individual A, the Insured/Owner, terminated a cash value policy and surrendered it for the $78,000 surrender value. $64,000 of premiums had been paid. The resultant gain of $16,000 was taxed as ordinary income. This calculation has not changed.

Federal taxation of life insurance policy sales has been improved.

IRS Revenue Ruling 2020-05 (February 12, 2020) provided this example wherein Individual A sold his policy for $80,000. The $78,000 of surrender value and $64,000 of premium payments were the same as when the policy was terminated and surrendered.

Taxable income per Revenue Ruling 2009-13 published May 1, 2009:

  • $26,000 was taxable as ordinary income.

Per Revenue Ruling 2020-05:

  • $14,000 was taxable as ordinary income.
  • $ 2,000 was taxable as long-term capital gains.

The link for Revenue Ruling 2020-05 is in the Addendum.

Example: Individual B

Individual B sold a 15-year level term policy for $20,000. $45,000 of premiums had been paid.

Taxable income per Revenue Ruling 2009-13 published May 1, 2009:

  • $19,750 was taxable as ordinary income.

Taxable income per Revenue Ruling 2020-05 published February 12, 2020:

  • Zero taxable income. All $20,000 of premiums were counted as the basis.

Federal tax refunds are subject to the statute of limitations.

  1. The effective date of Revenue Ruling 2020-05 is retroactive for all sale transactions on or after August 26, 2009.
  2. Tax refunds are subject to the statute of limitations, often two or three years, but
    require a tax professional before filing.

ADDENDUM

(A) Cash value policy surrenders and all life insurance policy sales may also be subject to taxation in certain states. The focus of this narrative is taxation by the Internal Revenue Service, part of the U. S. Department of the Treasury.

(B) The Insureds in each IRS example were not terminally or chronically ill.

(C) American Life Settlements ® discusses two-exempt options for life insurance policies that were created by HIPAA, formally known as Public Law 101-191, Health Insurance Portability and Accountability Act of 1996.

  1. Viatical Settlements are tax-exempt policy sales.Click here for more information about Viatical Settlements.The Viatical Settlement is the first of our two tax-exempt sections. To qualify, the Insured must obtain a physician’s certification of probable death within 24 months. A Viatical Settlement Provider buys the policy, makes a lump-sum payment to the Policy Owner, pays premiums, and collects the death benefit. There are certain exceptions for business-related policies.
  2. The Accelerated Death Benefits is a tax-exempt feature of some life insurance policies.
    Click here for more information about the Accelerated Death Benefit.

The Accelerated Death Benefit is our second tax-exempt section. It is a carrier-sponsored feature in many, but not all, individual and group life insurance policies for terminally ill Insureds with a life expectancy ranging from 6 to 12 months, depending on the policy. The Policy Owner receives a tax-exempt loan from the carrier, continues paying premiums sufficient to keep the policy in force, and collects the net death benefit after the carrier deducts loan principal, interest, and fees. There are certain exceptions for business-related policies. American Life Settlements® is not involved as a Broker when an Insured might qualify for an Accelerated Death Benefit. We explain this without compensation as part of our fiduciary duty.

Since 1998 almost all recipients of an Accelerated Death Benefit have kept the balance and not sold what was left. One 32-year-old male Servicemember received a $75,000 Accelerated Death Benefit from his $500,000 policy and we brokered the rest for $243,000.

References

HIPAA, full text:

IRS text:

Title 26 – Internal Revenue Code, 101. Certain death benefits

  • Pages 425-432
  • Link: <a href=”https://www.govinfo.gov/content/pkg/USCODE-2011-title26/pdf/USCODE-2011-title26-subtitleA-chap1-subchapB-partIII-sec101.pdfhttps://www.govinfo.gov/content/pkg/USCODE-2011-title26/pdf/USCODE-2011-title26-subtitleA-chap1-subchapB-partIII-sec101.pdf</li>

Internal Revenue Ruling 2009-13, May 1, 2009

Internal Revenue Bulletin: 2009-21, May 26, 2009

Internal Revenue Bulletin: 2020-05

IRS Refund Information Guidelines for the Tax Preparation Community

A non-profit resource for tax information: The Tax Foundation.

“The Tax Foundation is the nation’s leading independent tax policy nonprofit. Since 1937, our principled research, insightful analysis, and engaged experts have informed smarter tax policy at the federal, state, and global levels. For over 80 years, our goal has remained the same: to improve lives through tax policies that lead to greater economic growth and opportunity.”