Thought I'd help a little, but opt out for the original expert to clarify for you:
Here is Section 101 of the tax code:
§ 101. Certain death benefits
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(a) Proceeds of life insurance contracts payable by reason of death
(1) General rule
Except as otherwise provided in paragraph (2), subsection (d), subsection (f), and subsection (j), gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured.
(2) Transfer for valuable consideration
In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance contract or any interest therein, the amount excluded from gross income by paragraph (1) shall not exceed an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee. The preceding sentence shall not apply in the case of such a transfer-
(A) if such contract or interest therein has a basis for determining gain or loss in the hands of a transferee determined in whole or in part by reference to such basis of such contract or interest therein in the hands of the transferor, or
(B) if such transfer is to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer.
The term "other amounts" in the first sentence of this paragraph includes interest paid or accrued by the transferee on indebtedness with respect to such contract or any interest therein if such interest paid or accrued is not allowable as a deduction by reason of section 264 (a)(4).
(g) Treatment of certain accelerated death benefits
(1) In general
For purposes of this section, the following amounts shall be treated as an amount paid by reason of the death of an insured:
(A) Any amount received under a life insurance contract on the life of an insured who is a terminally ill individual.
(B) Any amount received under a life insurance contract on the life of an insured who is a chronically ill individual.
(2) Treatment of viatical settlements
(A) In general
If any portion of the death benefit under a life insurance contract on the life of an insured described in paragraph (1) is sold or assigned to a viatical settlement provider, the amount paid for the sale or assignment of such portion shall be treated as an amount paid under the life insurance contract by reason of the death of such insured.
(B) Viatical settlement provider
(i) In general The term "viatical settlement provider" means any person regularly engaged in the trade or business of purchasing, or taking assignments of, life insurance contracts on the lives of insureds described in paragraph (1) if-
(I) such person is licensed for such purposes (with respect to insureds described in the same subparagraph of paragraph (1) as the insured) in the State in which the insured resides, or
(II) in the case of an insured who resides in a State not requiring the licensing of such persons for such purposes with respect to such insured, such person meets the requirements of clause (ii) or (iii), whichever applies to such insured.
(ii) Terminally ill insureds A person meets the requirements of this clause with respect to an insured who is a terminally ill individual if such person-
(I) meets the requirements of sections 8 and 9 of the Viatical Settlements Model Act of the National Association of Insurance Commissioners, and
(II) meets the requirements of the Model Regulations of the National Association of Insurance Commissioners (relating to standards for evaluation of reasonable payments) in determining amounts paid by such person in connection with such purchases or assignments.
(iii) Chronically ill insureds A person meets the requirements of this clause with respect to an insured who is a chronically ill individual if such person-
(I) meets requirements similar to the requirements referred to in clause (ii)(I), and
(II) meets the standards (if any) of the National Association of Insurance Commissioners for evaluating the reasonableness of amounts paid by such person in connection with such purchases or assignments with respect to chronically ill individuals.
(3) Special rules for chronically ill insureds
In the case of an insured who is a chronically ill individual-
(A) In general
Paragraphs (1) and (2) shall not apply to any payment received for any period unless-
(i) such payment is for costs incurred by the payee (not compensated for by insurance or otherwise) for qualified long-term care services provided for the insured for such period, and
(ii) the terms of the contract giving rise to such payment satisfy-
(I) the requirements of section 7702B (b)(1)(B), and
(II) the requirements (if any) applicable under subparagraph (B).
For purposes of the preceding sentence, the rule of section 7702B (b)(2)(B) shall apply.
(B) Other requirements
The requirements applicable under this subparagraph are-
(i) those requirements of section 7702B (g) and section 4980C which the Secretary specifies as applying to such a purchase, assignment, or other arrangement,
(ii) standards adopted by the National Association of Insurance Commissioners which specifically apply to chronically ill individuals (and, if such standards are adopted, the analogous requirements specified under clause (i) shall cease to apply), and
(iii) standards adopted by the State in which the policyholder resides (and if such standards are adopted, the analogous requirements specified under clause (i) and (subject to section 4980C (f)) standards under clause (ii), shall cease to apply).
(C) Per diem payments
A payment shall not fail to be described in subparagraph (A) by reason of being made on a per diem or other periodic basis without regard to the expenses incurred during the period to which the payment relates.
(D) Limitation on exclusion for periodic payments
For limitation on amount of periodic payments which are treated as described in paragraph (1), see section 7702B (d).
For purposes of this subsection-
(A) Terminally ill individual
The term "terminally ill individual" means an individual who has been certified by a physician as having an illness or physical condition which can reasonably be expected to result in death in 24 months or less after the date of the certification.
(B) Chronically ill individual
The term "chronically ill individual" has the meaning given such term by section 7702B (c)(2); except that such term shall not include a terminally ill individual.
(C) Qualified long-term care services
The term "qualified long-term care services" has the meaning given such term by section 7702B (c).
The term "physician" has the meaning given to such term by section 1861(r)(1) of the Social Security Act (42 U.S.C. 1395x (r)(1)).
(5) Exception for business-related policies
This subsection shall not apply in the case of any amount paid to any taxpayer other than the insured if such taxpayer has an insurable interest with respect to the life of the insured by reason of the insured being a director, officer, or employee of the taxpayer or by reason of the insured being financially interested in any trade or business carried on by the taxpayer.