IRS Publication 559 — Survivors, Executors, and Administrators

Accelerated death benefits are amounts received under a life insurance contract before the death of the insured. These benefits also include amounts received on the sale or assignment of the contract to a viatical settlement provider. This exclusion applies only if the insured was a terminally ill individual or a chronically ill individual. This exclusion doesn't apply if the insured is a director, officer, or employee, or has a financial interest in any trade or business carried on by the beneficiary. Terminally ill individual. A terminally ill individual is one who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death in 24 months or less from the date of certification.

Chronically ill individual. A chronically ill individual is one who has been certified as one of the following.

• An individual who, for at least 90 days, is unable to perform at least two activities of daily living without substantial assistance due to a loss of functional capacity.

• An individual who requires substantial supervision to be protected from threats to health and safety due to severe cognitive impairment.

A certification must have been made by a licensed health care practitioner within the previous 12 months. Exclusion limited. If the insured was a chronically ill individual, exclusion of accelerated death benefits is limited to the cost incurred in providing qualified long -term care services for the insured. In determining the cost incurred, don't include amounts paid or reimbursed by insurance or otherwise. Subject to certain limits, exclude payments received on a periodic basis without regard to costs.

Interest option on insurance. If an insurance company pays interest only on proceeds from life insurance left on deposit, the interest is taxable.

Insurance received in installments. If a beneficiary receives life insurance proceeds in installments, the beneficiary can exclude part of each installment from income. To determine the part excluded, divide the amount held by the insurance company (generally the total lump sum payable at the death of the insured person) by the number of installments to be paid. Include anything over this excluded part in income as interest. Specified number of installments. If a beneficiary will receive a specified number of installments under the insurance contract, figure the part of each installment the beneficiary can exclude by dividing the amount held by the insurance company by the number of installments to which the beneficiary is entitled. In case the beneficiary dies before receiving all the installments, a secondary beneficiary is entitled to the same exclusion. Example. As beneficiary, you choose to receive $100,000 of life insurance proceeds in 10 annual installments of $11,000. Each year, you can exclude from your income $10,000 ($100,000 ÷ 10) as a return of principal.