IRS §101(g): Tax treatment of viatical proceeds
When life settlement proceeds are excluded from federal income tax, the certification process, and how states treat them.
The short version
- Tax-free ifInsured is certified terminally or chronically ill
- Terminal definitionLife expectancy ≤ 24 months
- Chronic definition2+ ADL impairments or cognitive impairment
- Authority neededLicensed physician certification
- State treatmentMost states follow federal
What §101(g) actually says
Internal Revenue Code §101(g), enacted as part of HIPAA in 1996, treats certain “qualified accelerated death benefit” payments and viatical settlement proceeds as if they were paid on account of the insured’s death — meaning they’re excluded from gross income for federal tax purposes.
To qualify, the insured must be either:
- Terminally ill: certified by a licensed physician as having an illness reasonably expected to result in death within 24 months, OR
- Chronically ill: unable to perform 2+ activities of daily living for at least 90 days, OR requires substantial supervision due to cognitive impairment
What this means for cancer patients
Most cancer patients with Stage III or IV diagnoses, or any terminal diagnosis, qualify under the terminal illness definition. Earlier-stage patients may qualify under the chronic illness definition if treatment substantially impairs ADLs.
The certification has to be in writing from a licensed physician, and the settlement provider keeps it on file. Patients don’t need to file anything special with the IRS at the time of the settlement — proceeds simply aren’t reported as income.
State tax treatment
Most states conform to federal treatment. A few states (notably California and Wisconsin) have separate state-level rules that may treat some life settlement proceeds as taxable. We recommend consulting a state-licensed tax professional in your specific state.
What’s NOT tax-free under §101(g)
- Life settlements (as opposed to viatical settlements) for patients who don’t meet the §101(g) certification — proceeds are partially taxable
- Cash value portions exceeding basis (premiums paid) — generally taxable as ordinary income
- Gains above the policy’s cash value — taxable as long-term capital gain
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