Deduct Life Insurance Premiums or Not?

By February 10, 2015 Business, Taxes

Yes and No.

We are considered a small tax firm.  We will do around 1,500 tax returns in 2015.  Even with such a small percentage of the millions of tax returns filed each year with the IRS, we often see clients expensing their life insurance premiums.

In general, you are not allowed to deduct life insurance premiums.  Code Section 264 gives all the boring tax language explaining that.  The main reason your life insurance premiums don’t qualify as a business deduction is because you, the taxpayer, are directly or indirectly the beneficiary of the policy.

The IRS tells us what they think being the beneficiary directly or indirectly mean.

  • You can surrender the policy in exchange for its cash value
  • A taxpayer’s relative, business partner or creditor is named as the direct beneficiary; or
  • You can borrow against the policy’s cash value.

For this reason, few exceptions apply where the life insurance premium can be deducted.  If you are being taxed as a partnership, s corporation, or sole proprietor, you probably have control over all aspects of your life insurance policy.  Therefore, not deductible.  It’s best to pay for your life insurance premiums out of your personal account.  If you’ve paid for them out of your business account, then please at least categorize those payments as “owner’s distribution.”

Group Term

You can write off premiums paid for life insurance for group term.  Same stipulations though.  As the employer you can’t be a direct or indirect beneficiary.  The IRS does also add in their generic statement that the cost of insurance when combined with the employee’s other compensation has to be “reasonable.” Luckily for us, we have no idea what they mean by that.  They probably don’t even know because most of them are morons.  The employee doesn’t recognize this benefit as income as long as the death benefit does not exceed $50,000.

Key Person Insurance

As the employer, you can deduct premiums paid on a policy insuring an officer or an employee if the premiums constitute an ordinary and necessary business expense and you aren’t a direct or indirect beneficiary.  In this case though, the employee has to claim the premiums you pay as compensation.  And it still all has to be “reasonable.”

Based on all those rules, if you are the employer, the only chance you have of writing off life insurance is to have a C Corporation.  But even in that scenario, you are still claiming that write off on your personal tax return as compensation.

 

2 Comments

  • Nathan Woodbury says:

    Hi John- I do know what is reasonable. There is a table provided for the “reasonable cost of insurance.” It is based on one year term rates for any specific age and gender of the employee. In general, it is extremely high relative what most people would actually pay for the coverage. Hence, most of the cost are deemed reasonable. The cost of insurance is the cost that an insurance company would charge for a term policy.

    • John Briggs says:

      The reasonable aspect only applies when the employer provides the insurance for employees that are not related to him or her. Even if the insurance is “reasonable” on the business owner, the business still can’t claim a deduction for it.

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