Viatical Settlement Taxation
Viatical settlements are usually not taxable. This is because they're considered an advance of a life insurance benefit, which is tax-free. However, it's essential to understand other tax implications that may occur upon receiving the funds before proceeding.
- Written by Christian Simmons
Christian Simmons is a writer for RetireGuide and a member of the Association for Financial Counseling & Planning Education (AFCPE®). He covers Medicare and important retirement topics. Christian is a former winner of a Florida Society of News Editors journalism contest and has written professionally since 2016.Read More
- Edited ByLamia Chowdhury
Lamia Chowdhury is a financial content editor for RetireGuide and has over three years of marketing experience in the finance industry. She has written copy for both digital and print pieces ranging from blogs, radio scripts and search ads to billboards, brochures, mailers and more.Read More
- Reviewed ByEbony J. Howard, CPA
Ebony J. Howard, CPA
Credentialed Tax Expert at Intuit
Ebony J. Howard is a certified public accountant and freelance consultant with a background in accounting, personal finance, and income tax planning and preparation. She specializes in analyzing financial information in the health care, banking and real estate sectors.Read More
- Published: November 18, 2022
- Updated: September 16, 2023
- 3 min read time
- This page features 4 Cited Research Articles
- Edited By
- Viatical settlements are generally not taxable.
- There are tax differences between settlements for terminally and chronically ill sellers.
- Most states have regulations in place governing viatical settlements; details can vary from state to state.
- Consult with a trusted tax professional to examine the specific tax implications of your settlement.
A viatical settlement is a financial transaction in which a terminally or chronically ill person sells their life insurance policy to a third party for a lump-sum payout they can use while still alive. Given the requirement for a terminal or chronic diagnosis, choosing a viatical settlement is a sensitive and personal decision that warrants careful consideration of all the consequences, including tax implications.
Are Viatical Life Settlements Taxable?
The IRS excludes viatical settlements from federal income taxation. They are not considered capital gains but a pre-payment of the policy’s death benefit, meaning your lump-sum payment is not subject to federal tax.
Most states have regulations in place regarding viatical settlements, however, and tax details can vary from state to state. It is important to discuss any state-based implications with a tax specialist.
A viatical settlement lump-sum payment is excluded from taxable income, but only a portion of a life settlement is similarly excluded. Other portions can be treated as ordinary income and/or capital gains, depending on the size of your plan and premiums.
Tax-Free Viatical Settlement Requirements
The seller in a viatical settlement is called the viator. If the viator is terminally ill, meaning with a life expectancy of 24 months or less, the settlement payout is not taxable since it is part of the death benefit instead of a capital gain.
A viator might be chronically ill, which can have different tax implications. A chronically ill viator cannot perform at least two functions of daily living — like eating, bathing or dressing — without help. Monies used to pay for the viator’s care are generally not taxable, but if the lump-sum payment is used for other reasons there is a limit on how much is excludable tax-free per day.
In addition, most states have regulatory requirements for buyers of life insurance policies designed to protect viators. If the buyer does not meet those requirements, the viator may face tax consequences. Therefore, it’s important to have a thorough tax discussion with the viatical settlement company you choose.
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Frequently Asked Questions About Viatical Settlement Taxation
4 Cited Research Articles
- Life Insurance Settlement Association. (2021, June 9). Regulations Overview. Retrieved from https://www.lisa.org/regulations_overview
- National Association of Insurance Commissioners. (2009, July). Viatical Settlements Model Act. Retrieved from https://content.naic.org/sites/default/files/inline-files/MDL-697.pdf
- Internal Revenue Service. (n.d.). Information Reporting for Certain Life Insurance Contract Transactions and a Modification to the Transfer for Valuable Consideration Rules. Retrieved from https://www.irs.gov/pub/irs-drop/n-18-41.pdf
- Internal Revenue Service. (n.d.). Publication 525 (2021), Taxable and Non-Taxable Income. Retrieved from https://www.irs.gov/publications/p525