IRS Form 1099-LS reports the sale of a life insurance policy to a third party. The buyer of the policy — usually a life settlement company or investor with no personal tie to the insured — files the form with the IRS and sends you a copy so the sale is on record and you can figure out what you owe. The form itself only shows what you received; calculating tax requires a second form (1099-SB) and a three-tier calculation that splits your proceeds into a tax-free portion, an ordinary income portion, and a capital gain portion.
When You Receive a 1099-LS
A 1099-LS is triggered by a “reportable policy sale,” which federal tax law defines as the acquisition of an interest in a life insurance contract by someone with no substantial family, business, or financial relationship with the insured beyond the policy itself.1Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits A standard life settlement fits that description. Transfers to a family member, business partner, or your own corporation generally do not, and no 1099-LS is issued for those.
The acquirer files the form under Internal Revenue Code Section 6050Y and must report the payment amount, the sale date, the policy number, and the issuer’s name.2Office of the Law Revision Counsel. 26 USC 6050Y – Returns Relating to Certain Life Insurance Contract Transactions Expect your copy by January 31 of the year after the sale.
The Two Forms You Need Together
Form 1099-LS tells you the gross proceeds and the sale date.3Internal Revenue Service. Instructions for Form 1099-LS – Reportable Life Insurance Sale That is not enough on its own. You also need Form 1099-SB, “Seller’s Investment in Life Insurance Contract,” which the insurance company that issued the policy files. Two figures on the 1099-SB drive the calculation:4Internal Revenue Service. Instructions for Form 1099-SB
- Box 1, Investment in Contract: the insurer’s estimate of your total investment in the policy, generally the cumulative premiums you paid.
- Box 2, Surrender Amount: what you would have received had you surrendered the policy to the insurer instead of selling it.
Gross proceeds, investment in contract, and surrender amount are the three numbers you need. Your basis is not reduced for the cost-of-insurance charges the insurer deducts internally, so cumulative premiums stand as your basis in full.5Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis
How the Proceeds Are Taxed
Life settlement proceeds split into three tiers.
Tier 1, tax-free return of basis. The first dollars, up to your investment in the contract, are not taxable. This is the premium money coming back to you.
Tier 2, ordinary income. Any amount above basis but at or below the surrender value is taxed as ordinary income at your marginal rate. This mirrors the treatment you would have faced surrendering the policy back to the insurer.
Tier 3, long-term capital gain. Everything above the surrender value is taxed as a long-term capital gain, assuming you held the policy more than a year. Long-term rates for most taxpayers are 0%, 15%, or 20% depending on total taxable income.
Worked Example
Say you paid $100,000 in premiums, the surrender value is $150,000, and a settlement company pays you $250,000.
- First $100,000: tax-free return of premiums.
- Next $50,000 (from $100,000 to $150,000): ordinary income. At a 24% marginal rate, that is $12,000 in tax.
- Final $100,000 (from $150,000 to $250,000): long-term capital gain. At 15%, that is $15,000 in tax.
Total: about $27,000 on $250,000 in proceeds. Without the capital gain tier, the entire $150,000 gain could have been taxed at ordinary rates, so the split makes a real difference.
The Terminally or Chronically Ill Exception
If you are terminally or chronically ill and sell your policy to a licensed viatical settlement provider, the proceeds may be fully excluded from taxable income. The tax code treats those payments as if they were death benefits under the policy, which are generally tax-free.1Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits Two conditions apply:
- The insured qualifies medically. Terminally ill means a physician has certified an illness reasonably expected to result in death within 24 months. Chronically ill generally means inability to perform at least two activities of daily living without substantial assistance, and the exclusion for chronically ill sellers is narrower — limited to payments for qualified long-term care costs.
- The buyer qualifies as a viatical settlement provider, meaning it is regularly engaged in purchasing life insurance contracts from terminally or chronically ill individuals and is licensed in the insured’s state where licensing is required.
If both conditions are met, no three-tier analysis is needed and the entire payment is excluded. Sell to a buyer that does not meet the viatical settlement provider definition and the standard taxable treatment applies, even if you are terminally ill. The identity of the buyer controls the tax outcome here.
How to Report Each Tier on Your Return
The tax-free return of basis is not reported as income anywhere on your return. The other two tiers go in different places.
Ordinary Income Portion
Report the amount between your basis and the surrender value on Schedule 1 (Form 1040) as other income.6Internal Revenue Service. Schedule 1 (Form 1040) – Additional Income and Adjustments to Income Use the “Other income” line (Line 8z on recent versions) with a short description such as “life settlement — ordinary income portion.” The total from Schedule 1 flows to your Form 1040 and is taxed at your marginal rate.
Capital Gain Portion
Report everything above the surrender value on Form 8949 (Sales and Other Dispositions of Capital Assets) and carry it to Schedule D. Treat the policy as a capital asset you sold: enter the sale date from Form 1099-LS, the date you originally acquired the policy, and the proceeds allocable to the capital gain tier. The gain moves from Schedule D to your Form 1040.
If the Form Never Arrives
Your obligation to report the sale does not depend on receiving the 1099-LS. If the acquirer fails to send it, contact the settlement company to request one, and if it still does not arrive by early February, report the gain using the settlement agreement, closing documents, and your own premium payment records.
Backup Withholding on the Payment
Before paying you, a settlement company will ask you to complete a Form W-9 with your taxpayer identification number. If you do not provide a valid TIN, or the IRS has notified the payer that you previously underreported interest or dividend income, the company must withhold 24% of the payment and send it directly to the IRS.7Internal Revenue Service. Backup Withholding
Backup withholding is a prepayment, not an extra tax. You claim credit for it on your return, and any excess over your actual liability comes back as a refund. Providing a correct TIN on the W-9 before closing is the simplest way to avoid it.
State Taxes
Most states with an income tax will also tax your life settlement proceeds, but the treatment varies. States without an income tax add nothing to the federal bill. States that tax all income at a single rate apply that rate to your entire taxable gain without splitting ordinary income and capital gain. States with separate capital gains rates generally track the federal two-tier split above your basis. Check your state’s rules before filing, because the gap between ordinary and capital gains treatment at the state level can shift the total meaningfully.