TOLI Trustee Alert: The Taxation of a Life Settlement Policy Sale

The death benefit of a life insurance held in trust is received free of both estate and income taxes, but if a TOLI life insurance policy is sold, taxes may be due. The taxation of a life insurance policy is similar to a policy surrender for cash value, though the Tax Cuts and Jobs Act did simplify the process of calculating the tax amount.

Determining the taxation of a life settlement is essentially a three step process.

•  Ascertain total gain by subtracting the cost basis of the policy from the amount received from the sale by the policy owner
• Determine that amount which will be taxed as ordinary income: the difference between the cash value in the policy and the cost basis
•  Now, calculate that portion of the sale that will be taxed at capital gains rates by subtracting the amount taxed as ordinary income (second step) from the total gain (step one)

Note: if there is no cash value in the policy, the total amount received above cost basis is taxed at capital gains rates.

See TOLI Trustee Alert: The Taxation of a Life Settlement Policy Sale, ITM 21st, January 29, 2020.