Proposed Tax Bill Would Clarify Tax Treatment of Life Settlements

May 11, 2017 12:34:00 PM / by Robin S. Weinberger, Peter N. Katz

In May 2009, the IRS issued Revenue Ruling 2009-13 addressing the tax implications of a life settlement to the seller of a life insurance policy. H.R. 1262 was recently introduced to remedy the shortcomings of this revenue ruling.

Tax Ruling

In the 2009 ruling, the IRS created a distinction in the tax basis between policies that are surrendered and policies that are sold in a life settlement. For policies that are surrendered at a gain, the law has long been that the policy owner’s basis is their cumulative investment in the contract, which is basically the cumulative premiums paid less withdrawals and dividends taken from the policy.

But for purposes of a life settlement, the IRS ruled that the basis would have to be reduced by the cumulative cost of insurance charges assessed against the policy. For no apparent reason, the ruling puts the seller in a life settlement transaction in a less favorable tax position than someone who surrenders a policy.

Furthermore, the ruling created a number of unanswered issues with respect to the tax treatment of a life settlement transaction to the seller:

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