If you’re wondering if you can claim life insurance premiums as a business expense, the answer (like many tax questions) is, “It depends.”
Whether you can claim the expense is dependent on who benefits from the policy, and even in cases where you can claim life insurance as a business expense, you may not want to.
If you, as a business owner, are the direct or indirect beneficiary of the life insurance policy, you can’t deduct your life insurance as a business expense. If you’re self-employed and would like to deduct your life insurance premiums as a business expense, it’s not possible, as the IRS prohibits that practice.
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Claiming life insurance as a business expense
There are some cases where a business can claim life insurance premiums as an expense. However, depending on the intent of the policy, you may not want to claim the expense.
If the life insurance premiums were claimed as a business expense, the proceeds of the policy become taxable to the beneficiary. By taking the deduction on the business tax return, you’ve slashed the policy’s death benefit by as much as 40 percent. Taking the expense on your business taxes creates an instant tax liability for the beneficiary, possibly preventing the policy from serving its intended purpose.
It’s likely that the person who is insured by the policy thinks he is insured for the face value — and he is, but the beneficiary will have to pay the IRS as well as any applicable state taxes.
This perception that the life insurance policy will provide the full face value (tax-free) becomes relevant when you consider that more people are insured by group life insurance policies through an employer than by individually-owned life insurance policies. For a seemingly growing number of households and individuals, the group life policy they have through their employer is the only life insurance coverage they have at all.
When can I claim life insurance premiums as an expense?
Small businesses and corporations can claim life insurance as a business expense and often do. Life insurance is frequently provided as an employee benefit, along with health insurance. In this case, it’s common for businesses to deduct the cost of premiums along with any other employee expenses.
Common types of life insurance by businesses
Group life insurance
Employers often offer group health insurance, the premiums for which can be deducted as a business expense. A smaller percentage of employers also offer group life insurance policies,and yes, the life insurance premiums can be claimed as a business expense, similar to health insurance. However, according to the IRS, health insurance isn’t considered taxable, even though the business can deduct the expense. Group life insurance premiums, on the other hand, can be deducted as an expense but claiming the expense makes the proceeds of the policy taxable to the beneficiary.
Group life policies can be a great benefit and without any initial cost to the employee, there’s really no reason for an employee not to accept the benefit. It is, however, a benefit that isn’t always well understood, leaving many employees under the impression that they are insured for X amount by the group policy, when the real-world math of their coverage is much less after the tax man takes a bite.
Key man life insurance
Key man life insurance, also called key person life insurance, is a common way for businesses to protect themselves against potential financial loss due to the death of a key employee. With this type of life insurance, the business becomes the beneficiary because the business would suffer a significant financial loss without that key employee.
In a small business, the key person might be an owner or founder but can also be an employee who would be difficult or impossible to replace and whose absence from the business might threaten the business’s survival.
Imagine if you owned a French restaurant and the main draw of your business is one world-renowned chef who creates culinary masterpieces. If that chef unexpectedly dies, the prospects for your restaurant business begin to look grim.
A key man life insurance policy that insures that chef would pay the proceeds of the policy to the business, allowing you to cover expenses while you seek a high-dollar replacement chef, or close down your restaurant venture gracefully, possibly repaying investors and creditors with the proceeds of the key man life insurance policy.
Business income tax rules regarding business expense deductions for key man insurance become particularly murky. The consensus, or as close as the accounting community has come to reaching a consensus on this topic, is that you can’t claim the policy premiums if the business is the beneficiary of the policy.
Rules regarding life insurance as a business expense vary depending upon the business structure and the beneficiary of the policy. Lots of business owners get themselves into hot water — or at least lukewarm water — with the IRS for taking improper deductions. After the business taxes are paid, it’s business as usual and any available cash is used to fund the business, as usual.
If you’re self-employed or a business owner who would benefit directly or indirectly from the life insurance policy, unfortunately the IRS says you can’t claim life insurance as a business expense. In other cases, you might be able to claim life insurance as an expense, particularly in the case of group life insurance provided as a employee benefit.
When in doubt, don’t guess on this one. Ask a business financing and/or accounting expert.
Learn more information about life insurance costs and payouts.