Before you cash in your policy, you might have questions about how the IRS will tax your proceeds. Life settlement brokers are a great resource for this but don’t think of them as tax experts.
This is because every life insurance policy is different. Every taxpayer’s situation is different.
Additionally, most CPAs are usually not life settlement tax experts either. Many policyholders will request information on behalf of their accountant to help them get acquainted with the marketplace, the process, and how life settlement transactions are taxed.
Although we are not to be considered experts, we can offer a few pointers to help you and your accountant get started.
Your insurance policy is likely different from the next person’s policy. Variations to consider include:
These are just a few of the policy variations that can influence your tax bill. So, even if two policies of the same size sell for the same amount, they will likely still have different tax liabilities.
Carriers have similar products (Term, Universal Life, Whole Life), but their contracts can be different. Additionally, interest rates and policy provisions are different.
In many cases, companies will let their employees keep their life insurance policy when they retire. The premiums paid into the policy were paid both by the company and the employee. As a result, this creates a unique tax situation.
Your premium is the amount of money you pay in exchange for your life insurance. You pay premiums either annually, quarterly, or monthly. Your cost basis is the total amount that you have paid into your policy. Therefore, your policy is an asset and how much you have paid in premiums determines the cost basis.
Your policy’s age affects the cost basis. Of course, the longer you pay premiums the bigger your investment is in your asset. Finally, the amount of money you have in your policy will affect how it is taxed.
In most cases, having a loan against the policy can make it difficult to sell. However, it can be done. Additionally, loans against the policy can affect the amount of taxes owed.
The IRS taxes at different rates due to income. For example, someone who makes 75K a year will be in a different tax bracket than someone who makes 300K a year. So, imagine you had the exact same policy as your neighbor. You bought and sold the policy on the exact same days for the exact same amounts. Still, your tax bills would likely vary due to income.
A person’s life expectancy/health condition factors into the tax bill. For example, a person with significant health impairments, such as a terminal cancer diagnosis, would be considered a viatical settlement. In such cases, policyholders can sell their policies for cash tax-free.
At the state level, your taxes can vary based on your physical location. Consequently, taxes owed for residents of New York will be different from the taxes in Florida and California.
So you see, life settlement companies are not life settlement tax experts. However in most cases, CPAs and financial advisors aren’t either. Windsor can still be a great resource for CPAs and financial advisors working with their clients to sell a policy.
The Tax Cuts and Jobs Act (TCJA) in 2017 changed the way the IRS defines profit. The profit from selling your policy is the difference between the cost basis and the money you receive from selling the policy. Formerly, the IRS reduced your cost basis with “cost of insurance” charges. TCJA changed this. You’re taxed on the profit made from the sale. Consequently, the higher your cost basis, the less you will pay in taxes.
If the policyholder is chronically or terminally ill, they will likely pay little to no taxes. Then their transaction would be considered a viatical settlement. The taxes on a viatical settlement are much lower than a life settlement.
It’s your CPA’s job to get your tax situation sorted. This article explaining life settlement taxation is a great resource to send your accountant. It brings them up to speed on how your unique details play into life settlement taxation. It also talks about the change in tax laws that have made a huge impact on life settlement taxation. As a result, this change has made life settlements a wise financial choice for many people.
In conclusion, no two policies or tax situations are the same. A tax professional will dive into your specific situation to help you pay taxes. However, resources like Windsor will get you both on the right track to understanding life settlements.
You can check if you’re eligible for a life settlement with this life settlement calculator.
Finally, we’re ready to speak with you about your policy and answer your questions about life settlements.
Speak with a Windsor representative at 888-994-6376 or email email@example.com.
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