How are the proceeds from a life settlement taxed to the policy owner?
Internal Revenue Code Section 101 defines the cost basis for the policyowner in a life insurance policy as the total of premiums or other consideration paid. Gain to the policyowner in a transaction in which the policy is sold for valuable consideration is calculated by subtracting the cost basis from the consideration received. In most instances, the total premiums paid over the life of the policy, net of the cost of the pure insurance portion of the premiums, far exceeds the total of the cash surrender value and the purchase premium received by the policyowner in a life settlement. Thus, in most instances, there are no income tax consequences, just a return of capital. In the few instances where the consideration received by the policyowner in a life settlement transaction might exceed the total amount of premiums paid, the amount of the excess could be taxable as ordinary income, or as a capital gain, depending on how long the policy had been held by the policyowner.
