A viatical settlement offers cash to terminally ill individuals in exchange for their life insurance policies. The settlement company pays a portion of the policy’s face value to the insured. Upon the insured’s death, the company gains all rights to the policy. Generally, these payments to terminally ill individuals are not taxable.
The IRS categorizes money from such life insurance settlements as “accelerated death benefits.” According to the IRS’s Tax Guide for Seniors, viatical settlement taxes might not be owed under certain conditions. Payments under a life insurance contract or viatical settlement before the insured’s death are usually excluded from income if the insured is terminally or chronically ill.
IRS Publication 554 clarifies that this exclusion from income cannot be claimed by a beneficiary who is an employer or an investor in the insured’s company.
To exclude a life insurance settlement from your income and avoid viatical settlement taxes, you must have a terminal or chronic illness. Qualification criteria include:
- Certification by a physician of an illness or condition expected to result in death within 24 months following the certification.
- Certification of a chronic illness by a physician within the past 12 months.
If your life expectancy exceeds 24 months, benefits are taxed based on the amount of insurance premiums you have paid. The taxation of a life settlement is complex. It depends on life expectancy, premiums paid, and the settlement amount received. Settlements may be taxed as ordinary income or capital gain.
It is prudent to seek tax advice from a professional before committing to a settlement.
To meet the “chronic illness” requirement, you should have a loss of functional capacity that hinders performing two or more of the following activities for 90 days or more without significant help:
- Eating
- Using the toilet
- Moving from a bed to a wheelchair or from a wheelchair to a car
- Taking a bath or shower
- Getting dressed or undressed
- Controlling bowels or bladder
Individuals with severe cognitive impairment meet chronic illness requirements if substantial supervision is needed for their health and safety due to their mental condition. For the chronically ill, settlement money might be excluded from taxable income if used for long-term medical care. Money not spent on medical services has an exclusion limit.
We specialize in providing financial solutions, especially for those considering viatical settlements. Understanding these tax implications is vital, and we are here to guide you through each step of the process.
