The short answer
A qualifying viatical settlement can be free of federal income tax. For terminal illness, the insured person must have a physician's certification of a life expectancy of 24 months or less, and the buyer must meet federal requirements. Chronic illness has additional care and payment rules. The sale's name alone does not determine its tax treatment.
The IRS explains these exclusions in Publication 525, under accelerated death benefits, which include qualifying viatical payments.
Viatical tax treatment at a glance
| Situation | Federal tax treatment |
|---|---|
| Certified terminal illness | Proceeds can be fully excluded when the buyer and transaction meet federal requirements. |
| Qualifying chronic illness | Qualified-care and payment rules determine how much can be excluded. A chronic diagnosis alone is not enough. |
| Neither illness route applies | Other policy-sale tax rules apply. Some proceeds may still be untaxed; see our life settlement tax guide. |
This is general information. We recommend consulting a tax professional before you sell. Citizens Life Group does not provide tax advice.
When is a terminal-illness settlement tax-free?
A viatical settlement is a sale of a policy covering someone with a terminal or qualifying chronic illness. The insured person is the person whose life the policy covers. That person may be different from the policy’s owner, who is selling it.
For the terminal-illness exclusion, a physician must certify an illness or physical condition reasonably expected to result in death within 24 months after certification. That is the federal standard in Internal Revenue Code section 101(g). A diagnosis alone does not establish it, and a buyer’s estimate used to price the policy is not a substitute for the required certification.
The purchasing company must also qualify as a viatical settlement provider. It must regularly buy policies covering terminally or chronically ill people and hold the required provider license in the insured person’s state of residence. Where that state does not require licensing, the buyer must meet the applicable federal standards instead. The IRS provider requirements explain this distinction.
Check the legal buyer named in the agreement. Your broker represents you, the seller, as a fiduciary while arranging the sale. The broker’s license does not replace the purchaser’s qualification.
Do you have to spend the money on medical care? The qualifying terminal-illness exclusion has no medical-spending requirement. The chronic-illness rules below are different.
Certain business-related payments are excepted from the exclusion. If someone other than the insured receives payment because of a business-related interest in that person’s life, have the ownership and purpose of the policy reviewed. Section 101(g)(5) addresses this exception; it does not mean every business-owned policy has the same tax result.
What changes if the insured is chronically ill?
The federal meaning of chronically ill is narrower than having a long-standing illness. Under section 7702B(c), a licensed health care practitioner must have certified the qualifying condition within the preceding 12 months. The main qualifying conditions are:
- Needing substantial assistance with at least two of six daily activities because of a loss of functional ability, expected to last at least 90 days. Those activities are eating, toileting, transferring (such as moving from a bed to a chair), bathing, dressing and continence (bladder and bowel control).
- Needing substantial supervision to protect health and safety because of severe cognitive impairment.
The 90-day condition is not a waiting period. IRS Notice 97-31 explains that the assistance need can be expected to last that long; the person does not have to wait until 90 days have passed.
The buyer must meet the provider requirements described above. Meeting the health definition is only part of the tax analysis. Spending a sale payment on medical bills does not, by itself, establish the exclusion. The agreement and the way benefits are paid also matter:
- Payments for actual qualified care costs. Qualifying reimbursements can be excluded for expenses not reimbursed by insurance or otherwise. The care must meet the federal long-term-care definition and be provided under a plan prescribed by a licensed health care practitioner. Not every medical bill qualifies.
- Payments unrelated to actual care costs. Per-day and other payments made without regard to expenses have an exclusion calculation. Qualified-care costs, the applicable payment period, reimbursements and other relevant care benefits can affect the amount excluded.
The IRS explains the different exclusion rules for these payment arrangements.
A payment arriving as one lump sum does not automatically avoid the limits. Section 7702B(d) defines the relevant payments broadly enough to include one-time payments unrelated to actual care costs. Give your preparer the agreement and care records so they can determine which rules apply.
If you are unsure which health definition fits, begin with the medical certification and proposed agreement. Your health care practitioner and tax professional can address those questions without relying on the name used in a sales brochure.
Does Form 1099-LTC mean I owe tax?
No. Receiving a tax form does not, by itself, make the proceeds taxable. Form 1099-LTC is an information return used for long-term care benefits and certain accelerated death benefits, including qualifying viatical payments.
For a covered viatical sale, the provider reports the gross payment in Box 2. That amount is not a calculation of your taxable income. The IRS instructions for Form 1099-LTC also make the terminal/chronic illness checkbox optional. A blank illness box alone does not settle whether you qualify for an exclusion.
Keep your certification with the form. If the payment amount, names or other information appears wrong, ask the payer and your preparer to resolve it. Keep any corrected form with your records as well. Provide all documents received for the sale, even if another form has a different title.
Form 8853 may also be needed. Its Section C addresses certain long-term care and accelerated benefit payments, including payments on a per-day or other periodic basis. Filing can be required even when the resulting taxable amount is zero. Not every person receiving Form 1099-LTC has the same filing requirement.
Your preparer should use the Form 8853 instructions for the year you received the payment. Ask them to review the payment arrangement rather than assuming that “tax-free” means no reporting is needed.
What about state taxes and public benefits?
State income tax is a separate check. New Jersey’s guidance ties viatical treatment to the federal result, while New York’s instructions include a separate subtraction for certain federally taxable benefits. Have your preparer check your state’s rules; the federal answer alone is not a complete state-tax determination.
A settlement can also affect assistance based on income or assets. The Maryland Insurance Administration flags this issue for sellers, and Medicaid’s financial rules vary by eligibility category. Some categories have no asset test. If you receive means-tested assistance, ask the agency or a benefits counselor about the proposed payment before accepting it. An income-tax exclusion does not establish continued benefit eligibility.
What should I give my tax preparer?
Before signing, ask your tax professional to review the proposed agreement and the health certification relevant to the exclusion. Ask which federal rules apply, whether the buyer meets the provider requirements, and what state-tax issues need checking. If someone else owns the policy, make that clear at the start.
After the sale, keep these records together:
- Medical certification and its date. Keep the documentation supporting the terminal- or chronic-illness definition.
- The agreement and closing statement. Include the buyer's legal identity, payment terms and records of the amount received.
- Tax forms from the payer. Keep Form 1099-LTC, any other forms received for the transaction, and corrected copies.
- Policy and ownership records. Premium and other basis records may be needed if the exclusion does not apply.
- Chronic-illness care records, when relevant. Include the prescribed care plan, qualified-care expenses, reimbursements and other long-term care or accelerated-benefit payments for the same insured person.
You will not necessarily have a tax form before closing. The agreement and supporting records let your preparer start the review before those forms arrive. If the terminal-illness exclusion applies, you do not need records of medical spending to qualify for it.
Sources and further reading
The linked government sources support this guide. For tax preparation, these are the most useful starting points:
- IRS Publication 525: taxable and nontaxable income
- IRS instructions for Form 1099-LTC
- IRS instructions for Form 8853
We recommend consulting a tax professional about your transaction and filing requirements. Citizens Life Group does not provide tax advice.