Viatical settlement taxation turns almost entirely on the insured’s health at the time of sale. If a physician has certified you as terminally ill, the entire payment is excluded from your gross income. If you’re certified as chronically ill, the exclusion still applies but is capped at a daily amount and generally tied to qualified long-term care spending. If you meet neither standard, the sale is taxable, and the proceeds split into a tax-free return of basis, ordinary income, and capital gain.
Full Exclusion When the Insured Is Terminally Ill
Under Section 101(g) of the Internal Revenue Code, a viatical settlement paid to a terminally ill insured is treated as if it were a death benefit under the policy. Every dollar you receive is excluded from gross income, no matter how far it exceeds what you paid in premiums.1Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits
The tax code defines a terminally ill individual as someone whose physician has certified in writing that they have an illness or physical condition reasonably expected to result in death within 24 months of the certification date. That 24-month window is a hard line. A certification of 30 months doesn’t qualify, even if the actual prognosis later shortens; you’d need an updated certification reflecting the shorter timeline.1Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits
The exclusion has no dollar limit and no spending requirement. Whether the check is $50,000 or $500,000, and whether you use it for medical bills, a mortgage, or anything else, the proceeds are tax-free once the physician’s certification is in hand.
Chronically Ill: Exclusion With a Daily Cap
Certification as chronically ill also qualifies you for an exclusion, but with real limits. You’re chronically ill if a licensed health care practitioner certifies either that you cannot perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) without substantial assistance for at least 90 days because of a loss of functional capacity, or that you need substantial supervision to protect you from threats to your health and safety due to severe cognitive impairment.2Office of the Law Revision Counsel. 26 US Code 7702B – Treatment of Qualified Long-Term Care Insurance
Unlike a terminal-illness certification, the chronic-illness certification must be renewed by a licensed health care practitioner at least once every 12 months to keep the exclusion in place.3Internal Revenue Service. Instructions for Form 8853
The exclusion is capped at the IRS per diem for long-term care benefits. For the 2026 tax year, that cap is $430 per day. If the settlement, combined with any other long-term care insurance benefits, exceeds $430 per day, the excess is taxable unless you can document that your actual long-term care costs ran higher.4Internal Revenue Service. Revenue Procedure 2025-32
Qualified expenses include diagnostic, preventive, therapeutic, and rehabilitative services, along with personal care and maintenance services. Keep the receipts. If you can prove actual costs above the per diem cap, the exclusion follows those higher costs. If you can’t, the cap governs and the overage is taxed.
When Neither Health Standard Applies
If the insured doesn’t qualify as terminally or chronically ill, the transaction is a life settlement, not a viatical settlement, and the entire gain is taxable. Revenue Ruling 2009-13 sets the framework the IRS uses, splitting the proceeds into three layers based on the policy’s cash surrender value:5Internal Revenue Service. Revenue Ruling 2009-13
- Proceeds up to your adjusted basis come back tax-free. This is a return of the premium dollars you already paid in.
- The amount between your basis and the policy’s cash surrender value is taxed as ordinary income, representing the tax-deferred growth inside the policy.
- Anything above the cash surrender value is a capital gain, long-term if you held the policy more than a year.
A worked example makes this concrete. Say you paid $80,000 in premiums with no dividends or withdrawals, giving you an $80,000 basis. The policy’s cash surrender value is $95,000, and the buyer pays you $140,000. The first $80,000 is tax-free. The next $15,000 is ordinary income. The remaining $45,000 is a capital gain.5Internal Revenue Service. Revenue Ruling 2009-13
The ordinary income slice can bite harder than sellers expect, because it’s taxed at your marginal rate rather than the lower long-term capital gains rate.
The Buyer Must Be a Licensed Viatical Settlement Provider
The Section 101(g) exclusion only applies if you sell to a qualified viatical settlement provider. The statute requires that the buyer be regularly engaged in the business of purchasing life insurance contracts from terminally or chronically ill individuals, and be licensed for that purpose in the state where the insured lives. If your state doesn’t require licensing, the buyer must instead meet the standards in the Viatical Settlements Model Act published by the National Association of Insurance Commissioners.1Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits
Selling to an unlicensed buyer in a state that requires licensing disqualifies the transaction from the exclusion entirely, even if you’re terminally ill. The proceeds are then taxed under the standard life settlement rules. Confirm licensing before signing anything.
Figuring Your Basis in the Policy
Basis is irrelevant if you qualify for the full terminal-illness exclusion. For chronically ill sellers whose payments exceed the per diem cap, and for anyone taxed under the standard life settlement rules, basis is the pivot point.
Your basis is generally the total premiums you’ve paid over the life of the policy, reduced by any amounts you previously received tax-free such as policy dividends, withdrawals, and any outstanding loans you never repaid.6Internal Revenue Service. For Senior Taxpayers 1
The Tax Cuts and Jobs Act removed an earlier requirement, under Revenue Ruling 2009-13, that sellers reduce basis by the cumulative cost-of-insurance charges deducted inside the policy. That reduction no longer applies to policy sales, so basis is now simply total premiums minus tax-free amounts received. For sellers, that means less taxable gain.
Forms You’ll Receive and File
Receiving a tax form doesn’t automatically mean you owe tax. These are information returns; the actual tax outcome depends on how you report the transaction and whether you claim the exclusion.
Form 1099-LTC
When a viatical settlement provider pays a terminally or chronically ill insured, it reports the payment on Form 1099-LTC and sends copies to you and the IRS. For terminally ill sellers, the per diem limitation doesn’t apply. You claim the exclusion on your own return.7Internal Revenue Service. Instructions for Form 1099-LTC
Form 8853
Chronically ill individuals who receive per diem or periodic payments complete Section C of Form 8853 with their return. That’s where you apply the daily cap, compare it to actual qualified expenses, and calculate any taxable portion. Section C is also used for accelerated death benefits received as a chronically ill insured, even if you had no long-term care insurance payments.3Internal Revenue Service. Instructions for Form 8853
Forms 1099-LS and 1099-SB
If the sale is a standard life settlement rather than a viatical one, Section 6050Y requires the buyer to file Form 1099-LS reporting the payment, and the insurance company that issued the policy to report your investment in the contract on Form 1099-SB.8Office of the Law Revision Counsel. 26 US Code 6050Y – Returns Relating to Certain Life Insurance Contract Transactions You report the taxable gain on Form 1040, splitting it between ordinary income and capital gain. The IRS will have both the proceeds and your basis, so the numbers need to match.
Records to Keep
The burden of proving the exclusion is on you, not the buyer. Hang on to:
- The physician’s written certification of terminal illness, or the licensed health care practitioner’s certification of chronic illness. Renew the chronic-illness certification annually.
- Premium payment records going back to the original issue date, which establish your basis.
- Records of any dividends, withdrawals, or policy loans, since these reduce basis.
- The settlement agreement, along with evidence of the provider’s state licensing.
- Receipts for qualified long-term care expenses if you’re chronically ill and claiming actual costs above the per diem cap.
Missing paperwork can turn a tax-free transaction into a taxable one. The physician’s certification is the most critical single document; without it, the IRS has no basis to grant the exclusion regardless of how sick you actually are.
Watch for Higher Medicare Premiums
Any taxable portion of the settlement flows into your modified adjusted gross income. Medicare uses MAGI from two years prior to set Income-Related Monthly Adjustment Amounts for Part B and Part D premiums. One large taxable settlement can push you into a higher IRMAA bracket for the corresponding future year.
For 2026, IRMAA surcharges begin when individual MAGI exceeds $109,000, or $218,000 for married couples filing jointly, with higher surcharges at each tier above that. If the spike was a one-time event and your income has since dropped, you can ask the Social Security Administration to recalculate your IRMAA by filing Form SSA-44.9Social Security Administration. Request to Lower an Income-Related Monthly Adjustment Amount (IRMAA)
The surcharge issue doesn’t reach terminally ill sellers, whose proceeds are fully excluded and never hit MAGI. For chronically ill sellers, only amounts above the per diem cap or actual expenses count. For everyone else, the full taxable gain lands in MAGI and can raise Medicare costs down the road.