Any amounts received under a life insurance contract on the life of a terminally ill individual are excluded from gross income. Amounts received under a life insurance contract by chronically ill individuals are also excluded from gross income if certain requirements are satisfied. Similar exclusions apply when the amounts are received as a result of a sale or assignment of the life insurance contract to a viatical settlement provider.
Special Requirements for Chronically Ill Individuals – The nontaxable part of any amounts received under a life insurance contract on the life of an individual who is chronically ill is limited to the cost of qualified long-term care services.
Definitions:
Terminally Ill Individual - the term “terminally ill individual” means a person who has been certified by a physician as having an illness or physical condition that reasonably can be expected to result in death within 24 months of the date of certification.
Chronically Ill Individual – a “chronically ill” individual is one who has been certified within the previous 12 months by a licensed health care practitioner as:
(A) being unable to perform, without “substantial assistance” from another individual, at least two activities of daily living for at least 90 days due to a loss of functional capacity,
(B) having a similar level of disability as determined under IRS regs prescribed in consultation with the Dept of Health and Human Services, or
(C) requiring “substantial supervision” to protect the individual from threats to health and safety due to “severe cognitive impairment,” even if the individual is physically able.