Final answer:
The proceeds from a viatical settlement are usually not subject to income tax if the insured is terminally or chronically ill.
Step-by-step explanation:
A viatical settlement involves a policyholder selling their life insurance policy to a third party for more than its cash surrender value but less than its net death benefit. Such transactions are usually done when the policyholder is chronically or terminally ill and needs immediate cash for medical expenses or other urgent financial needs. Understanding the tax implications of these settlements is essential, as it affects the financial outcome for the seller.
The answer to whether capital gains on a viatical settlement are subject to income tax is nuanced. Generally, proceeds from viatical settlements are not subject to income tax if the insured is terminally or chronically ill. This can be found under the Health Insurance Portability and Accountability Act of 1996 (HIPAA), which provides that a viatical settlement by a terminally or chronically ill individual is treated as a sale of a life insurance policy that the taxpayer is relieved from paying taxes on.
Therefore, the received amount is generally tax-free, regardless of selling the policy at a loss, to a family member, or before the insured's death. Since selling a policy after the insured's death isn't possible (as the death benefit would then be payable to the named beneficiaries), only statements 2), 3), and 4) are plausible but do not typically result in a taxable event for a viatical settlement. However, it is key to consult a tax professional for current laws and regulations, as tax codes do change and the applicability can vary based on individual circumstances.