Writing Off Life Insurance: What You Need To Know

Life insurance premiums are generally not tax-deductible as they are considered a personal expense. However, there are specific scenarios where you might be able to claim a deduction. For example, if you are a business owner, you can deduct life insurance premiums you pay on behalf of your employees or corporate officers as long as the company is not a direct or indirect beneficiary of the policy. Additionally, if you have an alimony agreement from before 2019 that requires you to pay for life insurance on your ex-spouse, those premiums may also be deductible. While life insurance premiums are typically not tax-deductible, there are other tax advantages to having a life insurance policy. For instance, the death benefit is usually tax-free for beneficiaries, and the cash value in certain policies grows tax-deferred.

Life insurance premiums for businesses

Life insurance premiums are generally not tax-deductible. However, if you are a business owner, there are certain situations in which you may be able to deduct life insurance premiums as a business expense.

S-Corps & LLCs

If your company is structured as an S-corporation or LLC, you can deduct life insurance premiums as a business expense if the following criteria are met:

• The company offers a life insurance policy as an employee benefit via a group plan.
• If the plan is only available to executives, the premiums must be reported as wages.
• If the coverage reaches $50,000 or more, that amount must be listed as wages on the employee's W-2.
• You cannot deduct life insurance as a business expense if you are the beneficiary of the employee's policy.

C Corporations

The IRS prohibits C corporations from taking any type of deduction on life insurance premiums.

Other Business Insurance Deductions

While life insurance premiums are generally not tax-deductible, there are other types of business insurance that may provide tax relief:

• Liability insurance: General and professional liability insurance can cover professional lawsuits and can be deducted as a business expense.
• Business interruption insurance: This type of policy can reimburse eligible losses if your business is shut down due to a covered event, such as a fire, and the premiums may be tax-deductible.
• Commercial property insurance: Similar to homeowners or renters insurance, commercial property insurance covers lost or damaged business property, and premiums may be deductible.

Alimony Agreements

If you have an alimony agreement that requires you to pay for life insurance on your ex-spouse and the agreement went into effect before 2019, you may be able to deduct the premiums. However, due to tax code changes, alimony payments are no longer tax-deductible for agreements made in 2019 or later.

Donating Policy to Charity

If you donate your life insurance policy to a charitable organization, the premiums you pay into the policy may be tax-deductible. This is usually done with a permanent life insurance policy.

Key Employees

Business-owned life insurance policies are typically taken out on essential parties, such as owners, stakeholders, and top executives, to ensure the life of the business. In most cases, premiums for these policies are not deductible and must be paid with after-tax dollars by the company. However, death benefits are generally not subject to income tax.

Notice and Consent Requirements

To ensure that life insurance proceeds are exempt from income tax, employers must comply with certain notice and consent requirements:

• The employee must be notified in writing that the company intends to insure their life and the maximum face amount for which they could be insured.
• The employer must obtain written consent from the employee to be insured under the contract and that the contract may continue after the employee leaves the company.
• The employee must be informed in writing that the company or a group of people, including the business, will be a beneficiary of any proceeds payable upon the employee's death.

IRS Form 8925

To report employer-owned life insurance contracts, businesses must file IRS Form 8925 annually. This form is used to disclose the funding of these life insurance contracts to the IRS.

Bottom Line

While life insurance premiums are generally not tax-deductible, there are some specific situations in which businesses may be able to deduct premiums as a business expense. It is important to consult with a tax professional to determine if your life insurance premiums qualify for any deductions.

Alimony agreements before 2019

Alimony agreements are a type of spousal support or spousal maintenance, where one spouse pays the other a certain amount of money in the event of a divorce. There are five primary types of alimony: temporary, permanent, reimbursement, rehabilitative, and lump-sum. Alimony agreements are court-ordered and can be weekly, bi-weekly, or monthly.

Prior to 2019, alimony payments were tax-deductible for the payer and taxable for the recipient. However, due to changes in the tax code as a result of the Tax Cuts and Jobs Act, alimony payments are no longer tax-deductible for agreements made in 2019 or later. Therefore, for alimony agreements made before 2019, the payer spouse could deduct the payments from their taxable income, while the recipient spouse would have to include the amount received as income on their tax return.

It is important to note that alimony agreements made before 2019 but later modified to include the repeal of the deduction for alimony payments are not eligible for this tax deduction. Additionally, child support payments are never deductible and are not considered income.

Life insurance beneficiaries are charitable institutions

Life insurance premiums are not usually tax-deductible. However, there are certain circumstances in which they are. One of these is when the policy beneficiary is a charitable institution.

Naming a Charity as a Beneficiary

If you name a charitable institution as the beneficiary of your life insurance policy, you cannot write off your premium payments as a tax deduction. However, you can still reduce your taxable estate by the amount of the death benefit. This can save thousands of dollars in estate taxes for upper-income taxpayers.

You can name multiple beneficiaries and specify what percentage of the death benefit should go to each. For example, you could give 20% of your benefit to charity and 80% to your family. Alternatively, you could name a charity as a secondary beneficiary, or contingent beneficiary, who would receive the insurance payout if your primary beneficiaries cannot accept the death benefit.

Donating Your Policy to a Charity

If you donate your life insurance policy to a charitable institution, any premiums you pay toward the policy after the date of the donation are tax-deductible. This is usually done with a permanent life insurance policy. The charity becomes the owner and the beneficiary of the policy and can either surrender the policy and take its cash value or keep the policy active and continue to grow the cash value. If the charity keeps the policy active, you can continue to pay the premiums by paying them to the charity. Both these premiums and the policy are deductible on your income taxes.

Charitable Giving Riders

Charitable giving riders are additional features that can be purchased to customise a life insurance policy. They pay out an additional amount to the charity of your choice when you die, without detracting from the death benefit to your beneficiaries. Some insurers may include the rider at no additional cost, but it depends on the company. The charity chosen has to be recognised by the IRS, usually as a 501(c)(3) organisation.

Business-related premiums

Life insurance is a crucial aspect of financial planning, providing peace of mind and ensuring your loved ones are taken care of in the event of your passing. While life insurance itself is a personal expense, there are scenarios where you can write off life insurance premiums as a business expense, particularly when the insurance is business-related.

Business-related life insurance premiums can be tax-deductible, offering a valuable opportunity for business owners and the self-employed to reduce their tax liability. Here are some key considerations regarding business-related life insurance premiums:

Key Person Insurance: This type of insurance protects a business against the financial loss resulting from the death of a key employee. The business is the beneficiary of the policy and pays the premiums, which are generally tax-deductible as a business expense. This type of insurance is particularly relevant for businesses that rely heavily on the expertise, relationships, or revenue generated by specific individuals.

Estate tax considerations

While the death benefit is generally income tax-free, it may still be subject to estate taxes. Here are some key considerations regarding estate tax and life insurance:

• Estate Tax Exemption: The IRS allows a lifetime tax exemption on gifts and estates, which is adjusted annually for inflation. For 2024, the estate tax exemption is set at $13.61 million. As life insurance proceeds are considered part of a beneficiary's taxable estate, careful planning is necessary to minimise potential estate taxes.
• Irrevocable Life Insurance Trust: One effective strategy to mitigate estate taxes is to set up an irrevocable life insurance trust. This allows the death benefit to bypass the estate, thereby reducing the overall taxable value of the estate. By placing the life insurance policy into the trust, it is no longer considered part of the insured's estate, and the proceeds are not included in the estate value for tax purposes.
• Gift Tax Implications: It is important to be mindful of gift tax implications when transferring a life insurance policy to someone else. Consult a tax advisor to navigate the complex rules surrounding gift taxes.
• Annuity Options: Some life insurance policies offer annuity options, providing a stream of income to the beneficiary. However, the tax treatment of these annuities can vary, so it is essential to understand the specific tax consequences.
• Business-Related Premiums: In certain scenarios, life insurance premiums may be treated as a deductible business expense. For example, when policies are used to fund buy-sell agreements, or when the business is contractually obligated to maintain a life insurance policy or take out key person insurance.

Frequently asked questions