Tax Implications of Life Settlements

At the time of this writing, there are no Internal Revenue Code provisions or IRS rulings pertaining specifically to the income taxation of life settlements. Many authorities use the following assumptions in calculating the projected tax liabiltiy:

• If the seller's policy cost basis (the total amount of net premiums paid) is higher than the life settlement amount, the seller will not realize any taxable income from the transaction

• If the life settlement amount is higher thant the seller's cost basis, the excess of the policy's cash surrender value at the sale date over the seller's basis is a taxable gain. It is unsettled whether the gain is treated as ordinary income and taxed at the seller's marginal tax rate or is treated as a capital gain.

• If the policy has no cash surrender value, or the surrender valuse is less than the policy's cost basis at the date of policy sale to the provider, then consistent with the assumption posed above, the excess of the settlement amount over the seller's cost basis could be treated as a taxable gain (ordinary income or capital gain, depending on the position the IRS takes).

This projected tax liability should be calculated by the seller's tax advisor as part of the initial life insurance versus life settlement "trade-off" evaluation, and certainly taken into account before accepting a life settlement offer. Also, it should be pointed out that the tax consequesces to the policy owner/seller receiving a cash payment during the insured's lifetime are not as favorable (or certain) as that of receiving the policy's death benefit.

Ethical Gidance:

In considering a life settlement, a life insuracne agent, attorney, accountant, or trust officer is expected to soley represent the best interests of the policy seller, regardless of the manner in which the advisor is compensated. Also, an advisory team is an approvriate collaborative tool that can better assure objectivity, client focus, and informed, fully disclosed decisions.

Tax Facts - Ethics copywright 2006 The National Underwritier Company