Understanding Tax Implications for Viatical Settlements


Understanding Tax Implications for Viatical Settlements

When faced with a terminal or chronic illness, managing finances becomes a critical concern for many individuals. One lesser-known option available is a viatical settlement. This arrangement involves selling one’s life insurance policy to a third party for a lump sum of cash. The amount received is typically a percentage of the policy’s face value. This can provide much-needed financial support during a difficult time.

Tax implications are a significant consideration in viatical settlements. Fortunately, under certain conditions, the cash received from such a settlement may not be taxable. This is often the case when the insured is considered terminally or chronically ill according to IRS guidelines. Specifically, money received as part of a viatical settlement may be excluded from income, providing a degree of financial relief.

For the exclusion from income tax to apply, the insured must be certified by a physician as either terminally ill, with a life expectancy of 24 months or less, or chronically ill. In the case of chronic illnesses, certain criteria relating to the insured’s ability to perform daily activities must be met. These include eating, using the toilet, moving, bathing, dressing, and controlling bowels or bladder. Severe cognitive impairment requiring substantial supervision also qualifies.

Taxation of viatical settlements is nuanced. It can vary based on factors such as the insured’s life expectancy, total premiums paid on the policy, and the settlement amount. Settlements may be treated as ordinary income or a capital gain, impacting the amount of tax owed. It’s advisable to seek professional tax advice before proceeding with a viatical settlement to ensure compliance and optimize financial outcomes.