Are Viatical and Life Settlements Taxable?

For a terminal diagnosis, usually not. For a life settlement, it's more nuanced.

Viatical settlement proceeds are generally free of federal income tax when the insured has been certified terminally ill (life expectancy under 24 months) or chronically ill and the money is used for qualified care — the same treatment as a tax-free death benefit. A life settlement for someone who is not ill can be partly taxable: roughly, amounts above what you paid in premiums may be taxed, some as ordinary income and some as capital gain.

Viatical settlements (terminal or chronic illness)

Under federal law, if a licensed physician certifies the insured as terminally ill (generally under 24 months to live), the settlement is treated like an accelerated death benefit and is usually income-tax-free. Chronic-illness cases can also qualify when proceeds go toward long-term care.

Life settlements (not ill)

Here the IRS generally treats your premiums paid as your cost basis. Proceeds up to that basis are tax-free; the portion above basis up to the policy's cash surrender value is taxed as ordinary income; and anything above that may be taxed as a capital gain. A 2017 law simplified the basis calculation in the seller's favor.

Other things that can matter

A settlement is a lump sum of cash, which can affect eligibility for means-tested benefits like Medicaid. And state tax rules vary. This is exactly the kind of thing to run past a tax professional before you sign.

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Common questions

Is a viatical settlement reported to the IRS?

The provider may issue a 1099-LS for the transaction, but qualifying terminal-illness proceeds are generally not taxable income.

Could selling affect my Medicaid?

Possibly — a lump sum can count as an asset. Ask an elder-law attorney if Medicaid is in the picture.