Life Settlement taxation has been simplified and reduced by the Tax Cuts and Jobs Act of 2017 (TCJA). Briefly:
Life Settlement funds received up to the policy’s tax basis are free of income tax.
Life Settlement funds received in excess of the policy’s tax basis up to the amount of the cash value are taxed at ordinary income tax rates.
Life Settlement funds received in excess of the cash value get favorable capital gains treatment.
This applies to all permanent life insurance policies. It also means that Term Life policies, which have no cash value, get favorable capital gains treatment on Life Settlement funds above the policy’s tax basis.
The TCJA accomplished the above by retroactively rescinding Treasury’s Revenue Ruling 2009-13 for all Life Settlements after August 25, 2009 and clearly explaining Life Settlement taxation.
On another matter, the TCJA doubled the exemptions for the Estate Tax, Gift Tax, and Generation-Skipping Transfer (GST) to $11.2 million for single individuals and $22.4 million, with portability, for married couples. These 2018 numbers will be indexed for inflation.
Fewer people will be subject to such taxes, but they and all other personal tax cuts in the TCJA will revert to their 2017 levels (adjusted for inflation) beginning January 1, 2026, without Congressional action.