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If there is no cash surrender value (CSV) or if the CSV is lower than the cost basis in the policy, then the taxable income is the dollar difference between the settlement amount minus the cost basis of the policy. That amount is treated as a capital gain.
Capital Gains Tax = Settlement Amount - Cost Basis
If the CSV is higher than the cost basis, then that difference is treated as ordinary income and taxed according to the policy owner’s tax bracket. Then, the difference between the settlement amount and the CSV is treated as a capital gain.
Ordinary Income Tax = CSV - Cost Basis
Capital Gains Tax = Settlement Amount - CSV
If the cost basis in the policy is actually higher than the settlement amount, there should not be any taxable income from the transaction.
No Taxable Income = Settlement Amount - Cost Basis = ( - ) Negative Value (Loss)
*Please remember that these are general guidelines and cannot be relied upon as fact. The tax implications of a settlement should be considered prior to the transaction. This information is not tax guidance. As with any tax related issue, The Quantum Group advises you to consult your professional tax advisor.