Short answer: For a terminally ill insured (a physician certifies death is expected within 24 months), the accelerated amount is treated like a death benefit and is tax-free. For a chronically ill insured it is tax-free only within long-term care limits: actual qualified care costs, or the per diem limit of $430 per day for 2026.
The tax code treats amounts received under a life insurance contract on a terminally ill insured as paid by reason of death, so they are excluded from income. Terminally ill means a physician has certified an illness or condition reasonably expected to result in death within 24 months.
For a chronically ill insured (unable to perform 2 of 6 activities of daily living for at least 90 days, or needing substantial supervision because of severe cognitive impairment), the payment qualifies only if it meets the long-term care rules. Periodic payments that are not tied to actual costs are combined with any long-term care insurance payments on the same person; the amount above the greater of actual qualified care costs or the per diem limit is taxable. For 2026 the per diem limit is $430 per day.
The exclusion does not apply when the payment goes to a business that holds the policy on an employee, officer or director. Whether a rider pays on a terminal or chronic illness basis, and how, is in the contract.