Are policy owners taxed on life settlement proceeds? If so, how would they know of any potential tax liability?
The sale of a life insurance policy may be a taxable event. On May 1, 2009, the IRS issued Revenue Ruling 2009-13, which defines an individual policy owner’s tax liability on the proceeds from the sale of a life insurance policy in a life settlement transaction. Upon the sale of a cash value life insurance policy: • The recognized gain is the difference between the net amount to client and the policy owner’s adjusted basis. • The adjusted basis is determined by subtracting the cost of insurance from the total premiums paid. This amount is received tax free as a return of cost basis. • Any recognized gain greater than the adjusted basis and less than the policy’s cash surrender value will be taxed as ordinary income. • Any recognized gain above the policy’s cash surrender value will be taxed as a capital gain. In the sale of a term policy: • The premiums paid and the cost of insurance are both assumed to be equal, which means the adjusted basis will always be $0. • Any recognized gain w
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