Writing Off Life Insurance: Corporate Strategies And Benefits

Life insurance is an important consideration for business owners and corporations, but can it be written off as a tax-deductible expense? The short answer is: it depends. While life insurance premiums are generally not tax-deductible for individuals, there are some instances where they may be deductible for businesses. For example, if a business offers life insurance as an employee benefit, the premiums may be tax-deductible, depending on the business classification status. Additionally, businesses can deduct life insurance premiums if they are considered taxable income for the employee receiving coverage. On the other hand, life insurance owned by a C-corporation is considered a non-deductible expense, and if the business owner or LLC benefits from the coverage, the premiums are also non-deductible. The deductibility of life insurance premiums can also vary based on corporate structure and the type of life insurance policy in place.

Tax deductions for life insurance premiums

Life insurance premiums are generally not tax-deductible for individuals or businesses. However, there are certain scenarios where they may be deductible. Here are some instances where life insurance premiums may be tax-deductible:

For Individuals

• Using life insurance as collateral: Individuals may get a tax deduction if they use their life insurance policy as collateral on a loan. It is recommended to consult an accountant or tax professional to determine if this is possible in a specific situation.
• Self-employed individuals: Self-employed individuals can deduct health, dental, and long-term care insurance premiums. They can also deduct business-related insurance premiums, subject to certain limits.
• Charitable giving: If an individual owns a life insurance policy and names a charity as the beneficiary, their estate will receive a tax credit for the death benefit received by the charity. It is important to seek tax advice before implementing this strategy.

For Businesses

• Group term life insurance: If a business pays the premiums for its employees' group term life insurance, these premiums are tax-deductible as long as they are considered a reasonable business expense.
• Life insurance used for charitable giving: If a charity owns the life insurance policy, the business can receive a tax credit for the premiums paid. Tax advice should be sought for this strategy.
• Employee benefits: A business can offer life insurance policy coverage as an employee benefit, and the premium payments may be tax-deductible depending on the business classification status. For example, S corporations and LLCs can deduct life insurance premiums if they offer a group plan to employees. However, the plan must not be exclusive to executives, and the business cannot be the beneficiary of the employee's policy.
• Key person insurance: While premiums are not deductible, businesses can receive tax-free death benefits from key person insurance policies.
• Group health insurance: Businesses can deduct premiums for group health insurance as long as they are considered a reasonable business expense. However, this does not apply if the premiums are paid for a non-employee shareholder.

Corporate-owned life insurance (COLI)

COLI is also referred to as company-owned life insurance, dead peasant insurance, and employer-owned life insurance (EOLI). It is different from group life insurance as neither the employee nor their heirs benefit from the policy. However, in some instances, the company may agree to share the payout with the insured's family.

Businesses can take out COLIs to recoup the cost of funding employee benefit programs, to help cover lost revenue and hiring costs after the insured passes away, and to gain significant tax benefits. Key person insurance is a type of COLI used to cover critical employees, such as executives, owners, partners, or individuals with specialized positions.

COLIs are purchased as cash value insurance policies. The company pays the premium, and a portion of its payments are added to a cash value account to be invested or to gain interest at a fixed rate. As long as the policy isn’t surrendered prior to the death of the insured, investments earned from the cash value remain tax-free.

Funds can be withdrawn from the cash value of the COLI and used to pay the premiums or as loans. If the company takes a loan against the cash accumulated, the interest paid may also be tax-deductible, depending on how the proceeds are used as defined by the U.S. Congress and the IRS.

To enact a COLI, the insured employee must consent to having their life insured. They must receive written notification from the company stating it will be the beneficiary of the policy and disclosing the coverage amount, and provide written consent to the company. The employee has the right to refuse, and the company may not retaliate against them.

Companies use COLI primarily for tax benefits. For example, the company will receive a tax-free death benefit if the insured employee dies and will have access to a tax-deferred or tax-free cash value account. The accumulated cash value funds are only taxable if the life policy is surrendered before the insured passes away. Companies can also take out loans against the cash value of the policy and deduct eligible interest on the loan from their taxable income.

Key person life insurance

Key person insurance is needed if the loss of a certain individual would be devastating to the company's future. For small businesses, this is usually the owner or founder, but it could also be an indispensable employee with highly specialized knowledge or skills, or someone who brings in a large portion of the company's revenue.

The death benefit from the insurance essentially buys the company time to find a replacement or implement other strategies to save or shut down the business. The money can be used to cover the costs of recruiting, hiring, and training a new employee, or to pay off debts, distribute money to investors, provide severance benefits to employees, and close the business down.

Key person insurance is also available as disability coverage in case the individual is incapacitated and no longer able to work.

The amount of insurance a company needs depends on the size and nature of the business and the key person's role. It is recommended to purchase key person insurance that is eight to ten times the key person's salary or the monetary value of the key person.

While premiums paid for a key person policy are generally not tax-deductible, any cash value that builds up in a permanent policy is tax-deferred, and small businesses can typically borrow against this monetary value without causing a taxable event. Additionally, the death benefit may not be taxable, depending on the policy amount and the state where the policy is owned.

Buy-sell agreements

A buy-sell agreement is a contract created by business owners to ensure that if one of the members passes away, becomes disabled, or retires, their ownership interest will be sold to the remaining partners or to the company. A life insurance buy-sell agreement requires business owners to take out life insurance that benefits each other or the business. This way, the proceeds of the policy will be available to pay for the deceased member's ownership interest.

There are several ways to structure a buy-sell agreement, each of which can be backed by life insurance:

• Redemption agreement: Also known as an entity-purchase agreement, this is when the company buys back the ownership interest of the exiting owner.
• Cross-purchase agreement: When the remaining owners purchase the exiting owner's share.
• Hybrid agreement: This provides additional flexibility as to who purchases the exiting owner's share.
• One-way buy-sell agreement: When there is only one owner of a company, a designated buyer pays for a life insurance policy on the owner.

When creating a buy-sell agreement, it is important to work with an attorney or online service provider to ensure it is done correctly and is legally binding.

Business loans and life insurance

Life insurance is often a prerequisite for business loans, especially for small businesses. Lenders want to ensure that the loan will be repaid, and life insurance provides that security. In the event of the borrower's death, the insurance company pays off the loan from the policy's death benefit, with any remaining benefits going to the borrower's named beneficiaries. This is known as a collateral assignment, where the lender is the primary beneficiary of the policy.

The amount and type of collateral available to repay the loan will determine the appropriate amount of life insurance. Most lenders will require the policy's death benefit to be equal to or greater than the current amount of the outstanding loan balance. The term length of the coverage should also match or exceed the duration of the loan.

Business loan life insurance is a wise decision to safeguard your organisation in the event of your death. It can help prove to lenders that you are serious about your business and have a plan in place should something happen to you. Life insurance can also be used to replace key workers, keep the business running, pay off outstanding loans, and avoid liquidating any business assets to pay off debts.

When it comes to the type of life insurance for business loans, term life insurance is the most popular choice for self-employed individuals and small business owners. Term life insurance offers a level death benefit with premiums guaranteed for between 10 and 30 years. By matching the term length closely to the business loan's amortisation schedule, you can minimise the premiums payable. Once the term insurance expires, the business loan should be fully repaid, and life insurance coverage may no longer be necessary.

Universal life insurance is another option for business loans, but it is less commonly used due to its higher cost. Universal life policies provide flexible premiums, death benefits, and cash values. The investment component allows policyholders to take out policy loans, make withdrawals, or collateralise against their cash value.

While life insurance is not always required for a business loan, it is a valuable tool to protect your business and provide peace of mind. It demonstrates to lenders that you are committed to your business's long-term success and have a plan in place to handle unforeseen circumstances.

Frequently asked questions