How do I Report a Viatical Settlement on My Tax Return

A virtual settlement is considered a financial organization in which a person who has possession of a life insurance policy disposes of their life insurance policy to an outsourced third party for a lump sum payment of cash. This amount is typically considered more than the cash selling value. This business deal is likely to happen when the policyholder has some sort of illness or a dire need for funds because of health conditions that require immediate attention. The lump sum is normally utilized to pay medical costs and other financial wants for the duration of the life expectancy that remains of the insured individual.

Because the settlement is related to the sale of the insurance policy, it also has tax responsibilities. For those who are the receivers of a viatical settlement, they should provide details of it on their tax return. Failure to report the viatical settlement on the tax return leads to legal problems and unexpected tax implications. Therefore, it is important to report the proceedings of a virtual settlement on your tax return.

Key Traits and Concepts

Before you go straight into the reporting process, it is important to understand some key concepts that are important when it comes to a viatical settlement:

•         The concept of viatical settlement is linked with the selling of a life insurance policy to a completely different party. These parties are normally a life settlement company. The seller of this policy is the recipient of a lump sum payment, and the buying party is held responsible for paying installments/premiums and gathering the death contribution to the policyholder’s course.
• To be eligible for the terminally ill aspect of the viatical settlement, the policyholder has to be terminally ill; this means they must have a remaining life of 24 months or less.
•         The life insurance policy is considered as a contract between the policyholder ad an insurance firm. The policy holder is liable to pay installments and the insurance firm must provide a death perk to the person recipient upon the policyholder’s death.
•         The death benefit is considered as the amount paid from the life insurance business to the inheritor to the recipient on the death of the person that was insured.
•         The cash surrender value of the policyholder decides either they can terminate the policy without a viatical settlement or not. This value is normally lower than the policy’s death advantage.
•         A firm that buys a life insurance policy by means of the viatical settlement is called a life settlement company. These firms normally incorporate a payment method based on installments for the exchange of the policy.

Tax Treatment of a viatical settlement

The tax implications of a virtual settlement are a lot tricky. It is important to understand that tax laws are involved in a virtual settlement. The Internal Revenue Service has some exclusive rulings related to the taxation of the viatical settlement. These rules are formulated to make sure that a policyholder doesn’t face any additional tax burdens after they receive their settlement.

Proceed Taxation for a viatical settlement

In many of the cases, the proceed from a viatical settlement are normally exempt from federal income taxes if a policyholder is severely/terminally ill. This is an important perk related to the viatical settlements as it provides the policyholder the leverage to utilize lump-sum payment without ever worrying about taxes for that income.

There are, however, some scenarios where a viatical settlement is taxable:

If the proceeds are more than a policy’s death benefit. This is the case when a settlement amount is normally more than the death benefit of the policy, and the excessive amount can be taxable as ordinary income.

If the policyholder isn’t terminally ill then there are different tax rules applicable. For instance. The proceeds in this case from a life settlement are liable to pay taxes if the seller isn’t exclusively terminally ill.

Also, if you are looking to sell the policy by using a viatical settlement, the IRS normally removes the proceeds from a taxable income if you are terminally ill. Also, you must also report the transaction and might require to incorporate amounts in your tax return. Especially for if a settlement cost is more than a policy’s death benefit.