How Are Viatical Settlements Taxed?

Rebecca Parson
Rebecca Parson

Rebecca Parson

Author

Rebecca Parson is a financial and tech writer with 10 years of experience writing about topics such as life insurance, commodities investing, and the SaaS industry. She has a master’s degree from Johns Hopkins University and a bachelor’s degree from the University of Mary Washington. Her writing has appeared at money.com, sacbee.com, cart.com, herodevs.com, blanchardgold.com, and more.

Brian OConnel
Brian OConnel

Brian O'Connel

Contributor

Brian O’Connell has been a contributing writer for U.S News & World Report since 2016. A former Wall Street bond trader and the author of two best-selling books; “The 401k Millionaire” and “CNBC’s Creating Wealth”, he has 20 years experience covering business news and trends, particularly in the business and financial sectors. He believes education is the best gift a financial consumer can receive – and brings that philosophy to every story he writes. His byline has appeared in dozens of top-tier national business publications, including CBS News, Bloomberg, Time, MSN Money, The Wall Street Journal, CNBC, TheStreet.com, Yahoo Finance, CBS Marketwatch, and many more.

By Rebecca Parson, Brian O'Connel
Author, Contributor, Life Insurance

Viatical settlements are usually not subject to taxes. If an insured person is terminally ill, or in some cases chronically ill, the settlement money they receive is considered an advancement of their life insurance benefit and is tax-free.

It is important to note that some situations may be exceptions to the rule. The IRS has a set of requirements for the proceeds to qualify for a tax-free viatical settlement. Some of these requirements apply to both you as the policyholder, and some apply to the buyer of your life insurance policy. To maintain your tax-exempt status, all of these requirements must be satisfied. Even if you fulfill your obligations, the viatical settlement will become taxable if your buyer is not compliant.

State Income Tax 

State tax laws vary between states and are often subject to change. While many states adhere to federal guidelines on viatical settlements, there are exceptions. Certain states mandate a minimum life expectancy of twenty-four months, while others states set it at less than thirty-six months. Some states lack clear guidelines on what qualifies as a viatical settlement. Furthermore, a few states make no distinction between life settlements and viatical settlements at all.

IRS Seller Guidelines

A terminally ill person who a doctor confirms has a life expectancy of less than twenty-four months or a person with a chronic condition who is not able to perform two or more activities of daily living will qualify for the proceeds of their viatical settlement to be tax-free. 

IRS Provider Guidelines

The IRS requires that the purchaser in a viatical settlement be licensed in the state where the insured lives and regularly purchases policies in viatical settlement transactions. These rules are in place to protect you from unlicensed and unscrupulous buyers. Your job is to know the requirements and avoid non-compliant purchasers whenever possible.

To comply with IRS regulations, the provider must be recognized as a viatical settlement provider to facilitate the sale of the policy. The IRS provides a specific definition for a viatical settlement provider. They are required to;

  1. Have a history of regularly purchasing life insurance policies from terminally ill and chronically ill insureds. 
  2. Is licensed in the state where the insured lives. If the state doesn’t require licensing, the provider must still adhere to the National Association of Insurance Commissioners (NAIC) guidelines regarding disclosing information in the Viatical Settlements Model Act. The provider must also follow the NAIC’s reasonable payment guidelines for terminally ill insureds, which specify minimum payouts based on the insured’s life expectancy. The lower the life expectancy, the higher the payout.

The seller must pay income tax on the viatical settlement proceeds if the purchaser doesn’t meet these requirements.

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