The Tax Cuts and Jobs Act of 2017 reduced and simplified the taxation of Life Settlement for every type of life insurance.
Life Settlement funds up to the policy’s tax basis are income tax-free.
Life Settlement funds above the policy’s tax basis up to the amount of the cash value are taxed at ordinary income tax rates.
Life Settlement funds above the cash value get favorable capital gains treatment.
This applies to Universal Life, Whole Life, and other variations of permanent life insurance policies.
Term Life policies, which have no cash value, get favorable capital gains treatment on Life Settlement funds above the policy’s tax basis.
These reductions in Life Settlement taxation are a result of the TCJA’s retroactive rescission of the Treasury Department’s Revenue Ruling 2009-13 for all Life Settlements after August 25, 2009.
The TCJA also doubled the exemptions for the Estate Tax, Generation-Skipping Transfer (GST) and Gift Tax, to $11.2 million for single individuals and $22.4 million, with portability, for married couples. These are 2018 numbers and will be indexed for inflation.
It must be noted that the above improvements in Life Settlement and Estate-related taxation are of a temporary nature. Unless a future Congress makes the individual tax cuts permanent by December 31, 2025, all individual tax cuts will revert to their respective 2017 levels prior to TCJA, adjusted for inflation.