Accelerated Death Benefit

March 13, 2024

61 / Are amounts received as living proceeds of life insurance and endowment contracts subject to withholding?

<div class="Section1"> Yes. A payee, however, generally may elect not to have anything withheld. Only the amount that it is reasonable to believe is includable in income is subject to withholding. Amounts are to be withheld from periodic payments at the same rate as wages. Payments are periodic, even if they are variable, if they are payable over a period of more than a year. If payments are not periodic, 10 percent of the includable amount is withheld. Payments to a beneficiary of a deceased payee are subject to withholding under the same rules.<a href="#_ftn1" name="_ftnref1">1</a> An election out of withholding will be ineffective, generally, if a payee does not furnish his or her taxpayer identification number (TIN, usually the payee's Social Security number) to the payor, or furnishes an incorrect TIN to the payor and the payor is so notified by the IRS.<a href="#_ftn2" name="_ftnref2">2</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 3405; Temp. Treas. Reg. § 35.3405-1T (A-9, A-10, A-12, A-17, F-19 through 24). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 3405(e)(12). </div>

March 13, 2024

59 / Are there any exceptions to the general rule that viatical settlements are not included as taxable income?

<div class="Section1">There is one exception to this general rule of non-includability for viatical settlements. The rules outlined above do not apply to any amount paid to any taxpayer other than the insured if the taxpayer has an insurable interest in the life of the insured because the insured is a director, officer or employee of the taxpayer or if the insured is financially interested in any trade or business of the taxpayer.<a href="#_ftn1" name="_ftnref1">1</a></div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 101(g)(5). </div>

March 13, 2024

62 / Does the surrender or sale of a life insurance or endowment contract ever result in a deductible loss?

<div class="Section1"> A loss deduction can be claimed only if the loss is incurred in connection with the taxpayer’s trade or business or in a transaction entered into for profit.<a href="#_ftn1" name="_ftnref1">1</a> If the surrendered contract is a life insurance policy, ordinarily there will be no deductible loss, even though the cash surrender value is less than the net premium cost. The IRC expressly provides that a taxpayer’s investment in the contract is the “aggregate premiums paid,” but this may be different than the contract’s “basis” ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="37">37</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="51">51</a>). The IRC, however, is silent with respect to cost basis for computing loss. Several courts have held that the portion of the premiums paid for life insurance protection cannot be included in the cost basis. They reason that this portion is not a recoverable investment, but a nondeductible expense.<a href="#_ftn2" name="_ftnref2">2</a> There can be no loss, therefore, if the cash surrender value equals the policy reserve. But if the contract is surrendered in a policy year in which the reserve exceeds the cash surrender value, the difference may be allowable as a loss, provided the policy was purchased in connection with the taxpayer’s trade or business or in a transaction entered into for profit.<a href="#_ftn3" name="_ftnref3">3</a> Apparently the Tax Court considers the purchase of a personal cash value policy as a transaction entered into for profit to the extent of the policy’s investment feature.<a href="#_ftn4" name="_ftnref4">4</a> A Texas district court, however, does not consider it a transaction for profit even to this extent.<a href="#_ftn5" name="_ftnref5">5</a> A different situation exists where, because of the insurance company’s insolvency, the policy owner receives less than the stated cash surrender value. In this case, the difference between the amount received and the stated cash surrender value is a deductible loss.<a href="#_ftn6" name="_ftnref6">6</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 165. <a href="#_ftnref2" name="_ftn2">2</a>.     London Shoe Co., Inc. v. Commissioner, 80 F.2d 230 (2d Cir. 1935); Century Wood Preserving Co. v. Commissioner, 69 F.2d 967 (3d Cir. 1934); Keystone Consol. Publishing Co. v. Commissioner, 26 BTA 1210 (1932). <a href="#_ftnref3" name="_ftn3">3</a>.     London Shoe Co. v. Commissioner, 80 F.2d 230 (2d Cir. 1935). <a href="#_ftnref4" name="_ftn4">4</a>.     Cohen v. Commissioner, 44 BTA 709 (1941); Fleming v. Commissioner, 4 TCM (CCH) 316 (1945). <a href="#_ftnref5" name="_ftn5">5</a>.     Arnold v. U.S., 180 F. Supp. 746 (N.D. Tex. 1959). <a href="#_ftnref6" name="_ftn6">6</a>.     Cohen v. Commissioner, 44 BTA 709 (1941); Fleming v. Commissioner, 4 TCM (CCH) 316 (1945). </div></div>

March 13, 2024

54 / What is the income tax treatment of an accelerated death benefit payment from a life insurance contract?

Generally, any amount received under a life insurance contract on the life of a terminally ill insured or a chronically ill insured will be treated as an amount paid by reason of the death of the insured.<a href="#_ftn1">1</a> Amounts received under a life insurance contract by reason of the death of the insured are not includable in gross income.<a href="#_ftn2">2</a> See Q <a href="javascript:void(0)">63</a>. Thus, an accelerated death benefit meeting these requirements will generally be received free of income tax. However, amounts paid to a chronically ill individual are subject to the same limitations that apply to long-term care benefits. Generally, this is a limitation of the amount of benefits per day ($430 in 2026, $420 in 2025, $410 in 2024, $420 in 2023 and $390 in 2022).<a href="#_ftn3">3</a> See Q <a href="javascript:void(0)">491</a>. More specifically, if the total periodic long-term care payments received from all policies and any periodic payments received that are treated as paid by reason of the death of the insured (under IRC Section 101(g)) exceed a per-diem limitation, the excess must be included in income (without regard to IRC Section 72). (If the insured is terminally ill when a payment treated under IRC Section 101(g) is received, the payment is not taken into account for this purpose.)<a href="#_ftn4">4</a> The per-diem limitation is equal to the greater of (1) a $430 per day limitation in 2026 ($420 in 2025, $410 in 2024, $420 in 2023 and $390 in 2022) or (2) the actual costs incurred for qualified long-term care services provided for the insured less any payments received as reimbursement for qualified long-term care services for the insured.<a href="#_ftn5">5</a> This figure is adjusted for inflation annually.<a href="#_ftn6">6</a> Accelerated death benefits paid to terminally ill individuals are not subject to this limit. <blockquote>Example. In 2026, Mr. Heller received qualified long-term care services for 30 days at a total cost of $7,500. A qualified long-term care insurance contract paid him a benefit of $425 per day, $12,750 total. In addition, $500 of the cost of the qualified long-term care services was reimbursed by another source. Thus, $500 of the $12,750 benefit is includable in income by Mr. Heller. </blockquote> A terminally ill individual is a person who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months following the certification.<a href="#_ftn7">7</a> A chronically ill individual is a person who is not terminally ill and who has been certified by a licensed health care practitioner as unable to perform, without substantial assistance, at least two activities of daily living (ADLs) for at least 90 days or a person with a similar level of disability. Further, a person may be considered chronically ill if he requires substantial supervision to protect himself from threats to his health and safety due to a severe cognitive impairment and this condition has been certified by a healthcare practitioner within the previous twelve months.<a href="#_ftn8">8</a> See Q <a href="javascript:void(0)">477</a>. The ADLs are: (1) eating; (2) toileting; (3) transferring; (4) bathing; (5) dressing; and (6) continence.<a href="#_ftn9">9</a><hr align="left" size="1" width="33%"></hr> <a href="#_ftnref1">1</a>. IRC § 101(g)(1). <a href="#_ftnref2">2</a>. IRC § 101(a). <a href="#_ftnref3">3</a>. IRC §§ 101(g)(3)(D), 7702B(d). <a href="#_ftnref4">4</a>. IRC § 7702B(d)(1). <a href="#_ftnref5">5</a>. IRC § 7702B(d)(2); Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34, Rev. Proc. 2024-40, Rev. Proc. 2025-32. <a href="#_ftnref6">6</a>. IRC §§ 7702B(d)(4), 7702B(d)(5). <a href="#_ftnref7">7</a>. IRC § 101(g)(4)(A). <a href="#_ftnref8">8</a>. IRC §§ 101(g)(4)(B), 7702B(c)(2)(A). <a href="#_ftnref9">9</a>. IRC § 7702B(c)(2)(B).

March 13, 2024

58 / Are there special rules regarding the income tax treatment of an amount received by a chronically ill insured from a viatical settlement provider?

<div class="Section1">There are several special rules that apply to chronically ill insureds. Generally, the tax treatment outlined above will not apply to any payment received for any period unless such payment is for costs incurred by the payee (who has not been compensated by insurance or otherwise) for qualified long-term care services provided to the insured for the period. Additionally, the terms of the contract under which such payments are made must comply with: <blockquote>(1)     the requirements of IRC Section 7702B(b)(1)(B) (defining “long-term care contract”); (2)     the requirements of IRC Sections 7702B(g) and 4980C ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="477">477</a>) that the IRS specifies as applying to such a purchase, assignment, or other arrangement (relating to consumer protection provisions); (3)     standards adopted by the NAIC that apply specifically to chronically ill insureds (if such standards are adopted, similar standards under number (2) above cease to apply); and (4)     standards adopted by the state in which the policyholder resides (if such standards are adopted, the analogous requirements under number (2) and, subject to IRC Section 4980C(f), standards under number (3) above cease to apply).<a href="#_ftn1" name="_ftnref1">1</a></blockquote> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 101(g)(3)(B). </div></div>

March 13, 2024

56 / Are there any exceptions to the general rule of non-includability for accelerated death benefits?

<div class="Section1">There is one exception to this general rule of non-includability for accelerated death benefits. Accelerated death benefits paid to (1) any taxpayer other than the insured if (2) the taxpayer has an insurable interest in the life of the insured because the insured is a director, officer, or employee of the taxpayer or if the insured is financially interested in any trade or business of the taxpayer, are exceptions from the special treatment afforded to payment of certain accelerated death benefits (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="54">54</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="55">55</a>).<a href="#_ftn1" name="_ftnref1">1</a><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 101(g)(5). </div></div>

March 13, 2024

57 / What is the income tax treatment of an amount received from a viatical settlement provider?

<div class="Section1"> A viatical settlement provider is “any person regularly engaged in the trade or business of purchasing, or taking assignments of, life insurance contracts on the lives of insureds” who are terminally or chronically ill, provided that certain licensing and other requirements are met.<a href="#_ftn1" name="_ftnref1">1</a> To be considered a viatical settlement provider a person must be licensed for such purposes in the state in which the insured resides. The IRS has provided guidance on when viatical settlement providers will be considered licensed.<a href="#_ftn2" name="_ftnref2">2</a> If any portion of a death benefit under a life insurance contract on the life of a terminally or chronically ill insured is sold or assigned to a viatical settlement provider, the amount paid for the sale or assignment will be treated as an amount paid under the life insurance contract by reason of the insured’s death.<a href="#_ftn3" name="_ftnref3">3</a> In other words, such an amount will not be includable in income ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="63">63</a>).<a href="#_ftn4" name="_ftnref4">4</a> A terminally ill individual is a person who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months following the certification.<a href="#_ftn5" name="_ftnref5">5</a> A chronically ill individual is a person who is not terminally ill and who has been certified by a licensed healthcare practitioner as being unable to perform, without substantial assistance, at least two activities of daily living (ADLs) for at least 90 days or a person with a similar level of disability. Further, a person may be considered chronically ill if the person requires substantial supervision to protect himself or herself from threats to his or her health and safety due to severe cognitive impairment and this condition has been certified by a healthcare practitioner within the previous twelve months.<a href="#_ftn6" name="_ftnref6">6</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="477">477</a>.The activities of daily living are: <blockquote>(1)     eating; (2)     toileting; (3)     transferring (moving oneself from a bed to a chair, to another chair, etc.); (4)     bathing; (5)     dressing; and (6)     continence.<a href="#_ftn7" name="_ftnref7">7</a></blockquote> If an insured resides in a state that does not require licensing of viatical settlement providers, the insured must meet the standards for either a terminally ill individual or a chronically ill individual.<a href="#_ftn8" name="_ftnref8">8</a> The requirements applicable to an insured who is a terminally ill individual are met if the person: (1) meets the requirements of Sections 8 and 9 of the Viatical Settlements Model Act of the NAIC, and (2) meets the requirements of the Model Regulations of the NAIC in determining amounts paid by such person in connection with such purchases or assignments.<a href="#_ftn9" name="_ftnref9">9</a> The requirements applicable to an insured who is a chronically ill individual are met if the person: (1) meets requirements similar to the requirements of Sections 8 and 9 of the Viatical Settlements Model Act of the NAIC, and (2) meets the standards of the NAIC for evaluating the reasonableness of amounts paid by such person in connection with such purchases or assignments with respect to chronically ill individuals.<a href="#_ftn10" name="_ftnref10">10</a> <hr> Planning Point: The term “viatical settlement” is technical in its definition that viatical settlements refer to only those cases where the insured under the policy is terminally ill. Where the insured is not terminally ill, the terminology of “high net worth transactions” or “senior settlements” may be more appropriate. Transactions involving senior settlements, rather than “viatical settlements” are not necessarily taxed in the same manner. <hr> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.       IRC § 101(g)(2)(B)(i). <a href="#_ftnref2" name="_ftn2">2</a>.       Rev. Rul. 2002-82, 2002-2 CB 978. <a href="#_ftnref3" name="_ftn3">3</a>.       IRC § 101(g)(2)(A). <a href="#_ftnref4" name="_ftn4">4</a>.       IRC § 101(a). <a href="#_ftnref5" name="_ftn5">5</a>.       IRC § 101(g)(4)(A). <a href="#_ftnref6" name="_ftn6">6</a>.       IRC §§ 101(g)(4)(B), 7702B(c)(2)(A). <a href="#_ftnref7" name="_ftn7">7</a>.       IRC § 7702B(c)(2)(B). <a href="#_ftnref8" name="_ftn8">8</a>.       IRC § 101(g)(2)(B). <a href="#_ftnref9" name="_ftn9">9</a>.       IRC § 101(g)(2)(B)(ii). <a href="#_ftnref10" name="_ftn10">10</a>.     IRC § 101(g)(2)(B)(iii). </div></div>

March 13, 2024

55 / Are there any special rules that apply to chronically ill insureds?

<div class="Section1"> There are several special rules that apply to chronically ill insureds. Generally, the tax treatment outlined in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="54">54</a> will not apply to any payment received for any period unless the payment is for costs incurred by the payee (who has not been compensated by insurance or otherwise) for qualified long-term care services provided to the insured for the period. Additionally, the terms of the contract under which the payments are made must comply with: (1) the requirements of IRC Section 7702B(b)(1)(B); (2) the requirements of IRC Sections 7702B(g) and 4980C that the Secretary specifies as applying to such a purchase, assignment, or other arrangement; (3) standards adopted by the National Association of Insurance Commissioners (NAIC) that apply specifically to chronically ill insureds (if such standards are adopted, similar standards under number (2) above cease to apply); and (4) standards adopted by the state in which the policyholder resides (if such standards are adopted, the analogous requirements under number (2) and, subject to IRC Section 4980C(f), standards under number (3) above cease to apply).<a href="#_ftn1" name="_ftnref1">1</a> “Qualified long-term care services” are defined as “… necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services, which…” are required by a chronically ill individual and are provided under a plan of care set forth by a licensed healthcare practitioner.<a href="#_ftn2" name="_ftnref2">2</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 101(g)(3)(B). <a href="#_ftnref2" name="_ftn2">2</a>.     IRC § 101(g)(4)(C); IRC § 7702B(c)(1). </div></div>