Life Insurance: A Legitimate Business Expense?

Life insurance premiums are generally not tax-deductible as the IRS considers them a personal expense. However, there are specific scenarios where they can be claimed as a deduction. For instance, if you're a business owner offering life insurance to your employees, you can write off those premiums as a business expense. This is applicable to certain business structures, such as LLCs and S corporations, but not C corporations. Additionally, the business cannot be a beneficiary of the policy. There are also tax implications if life insurance is tied to divorce proceedings or used as collateral for business loans.

Life insurance premiums for self-employed individuals

As a business owner, you can offer life insurance as an employee benefit, and in this instance, the premium payments could be tax-deductible depending on your business classification status. For example, if you have an S corporation or LLC, the company must offer a life insurance policy as an employee benefit via a group plan for the premiums to be tax-deductible. However, if the plan is only available to executives, the premiums must be reported as wages.

Another restriction is that you can't deduct life insurance as a business expense if you are the beneficiary of the employee's policy. For instance, a married couple running an S-corp together couldn't deduct their life insurance premiums if they listed each other as beneficiaries.

Life insurance is also not considered a business expense for self-employed individuals. However, if the policy covers employees, it might qualify as a deductible business expense.

Life insurance as a business expense

Life insurance premiums are generally not tax-deductible as the IRS considers them a personal expense. However, there are specific scenarios where life insurance can be claimed as a business expense.

Life Insurance as a Deductible Business Expense

If you are a business owner, there are certain situations where you can deduct life insurance premiums as a business expense.

• Group life insurance for employees: If you provide life insurance as an employee benefit, also known as group life insurance, and neither you nor the company are the policy's beneficiary, you can deduct the premiums as a business expense. This deduction is limited to the cost of $50,000 of coverage per employee.
• Alimony agreements from before 2019: If you have an alimony agreement or divorce decree that requires you to pay for life insurance on your ex-spouse and went into effect before 2019, you can deduct the premiums.
• Donating your policy to charity: If you donate your life insurance policy to a charitable organisation, any premiums you pay after the donation date are tax-deductible.
• Business loans: If you use a life insurance policy as collateral for a business loan, you may be able to deduct the interest portion of the premiums.
• S-Corps & LLCs: If your company offers a life insurance policy as an employee benefit via a group plan, you can deduct the premiums as a business expense. However, if the plan is only available to executives, the premiums must be reported as wages.

Life Insurance as a Non-Deductible Business Expense

There are also situations where life insurance premiums are not tax-deductible as a business expense.

• Self-employed individuals: If you are self-employed and pay for your own life insurance policy, you cannot deduct the premiums, even if you can deduct other expenses like health insurance.
• Spouse as an employee: If your spouse is an employee of your company and their policy pays out to you, you would benefit, and therefore you cannot deduct the premiums.
• C-Corporations: According to the Internal Revenue Code, life insurance owned by a C-Corporation is a non-deductible expense, regardless of whether the corporation owns or is the recipient of the policy.
• Key person insurance: If you are the beneficiary of an employee's policy, you cannot deduct the premiums as a business expense.
• Buy-sell agreements: Premiums paid for life insurance policies used to fund buy-sell agreements between business partners are not tax-deductible, regardless of who owns the policy.

Other Tax Implications of Life Insurance

While life insurance premiums are generally not tax-deductible, there are other tax-related considerations.

• Death benefit: The death benefit payout is usually not taxable, and the beneficiary will receive the full face value of the policy.
• Loans against cash value: Loans taken against the cash value of a life insurance policy are generally not taxable.
• Estate tax considerations: While the death benefit is generally income tax-free, it may be subject to estate taxes.
• Gift tax implications: Transferring a life insurance policy to someone else may trigger gift tax implications.
• Dividends: Some whole life insurance policies pay dividends, which are generally not taxable unless received in cash.

In conclusion, while life insurance premiums are typically considered a personal expense and are not tax-deductible, there are specific scenarios where they can be claimed as a business expense, depending on the business structure and the nature of the policy. It is important to consult with a tax professional to determine the deductibility of life insurance premiums in your specific situation.

Life insurance for employees

One of the advantages of group life insurance is that it is typically more affordable than individual policies. The rates are based on the overall health of the group, and many employers provide basic coverage at no cost to employees. Additionally, employees may not need to undergo a medical exam to qualify for group coverage, making it accessible to those who might otherwise require high-risk insurance.

However, employer-provided life insurance usually offers limited coverage amounts, typically based on the employee's salary. For example, coverage may be equal to one year's salary, which may not be sufficient for older employees with higher salaries, mortgages, and dependent family members.

Another consideration is that employer-paid life insurance is usually tied to employment. If an employee leaves the company, their coverage often ends, although some employers offer options to continue coverage. This type of coverage is also generally temporary, providing term life insurance rather than permanent coverage.

Despite these limitations, life insurance through an employer can be a convenient and cost-effective way for employees to protect their loved ones. It is important for employees to carefully review the terms of their employer's plan and consider supplementing it with additional coverage if needed.

Life insurance for alimony or divorce agreements

Life insurance is often overlooked during divorce proceedings, but it is an important consideration, especially for couples with children. Sorting out life insurance during a divorce protects the financial interests of both parties and their dependent children.

• Update beneficiaries: In most cases, married individuals list their spouse as the primary beneficiary of their life insurance policy. However, during a divorce, it is advisable to update the beneficiary to ensure that the ex-spouse does not profit from the policyholder's death.
• Account for cash value: Some life insurance policies, such as whole life and universal life, accumulate cash value over time. In a divorce, it is equitable to list the life insurance policy, including its cash value, among the marital assets to be divided.
• Protect alimony and child support: If one spouse has primary custody of the children and receives alimony or child support, maintaining a life insurance policy on the other spouse can safeguard this income stream. The benefit amount should be sufficient to replace the lost income until the children are financially independent.
• Consider a new policy for the custodial parent: If the custodial parent relies solely on their income to support the children, taking out a life insurance policy on themselves can provide financial protection for their dependents.
• Legal requirements: Depending on the state, a divorce agreement may mandate that an ex-spouse take out life insurance coverage, especially if there are children involved.
• Tax implications: While life insurance premiums are generally not tax-deductible, there may be tax implications during a divorce. Consult with a tax professional or financial planner to understand the tax treatment of life insurance in your specific situation.

Donating life insurance policy to charity

Donating your life insurance policy to charity is a great way to support your favourite causes, both during your lifetime and after your death. There are several ways to go about this.

Naming a Charity as Beneficiary

The simplest way to provide a charity with the death benefit proceeds from a policy is to name the charity of your choice as the beneficiary of your life insurance policy. While this doesn't offer the same income tax advantages as gifting a policy, it does reduce the donor's estate by the amount of the death benefit. Naming a charity as a beneficiary also ensures the privacy of the transaction, which can be important for donors who wish to keep their gifting intentions secret from their families or other heirs.

Gifting Policy Dividends

Policyholders can receive dividends paid to their life insurance policies in cash and donate them to charity. The dividends donated are deductible in the same way as premiums paid on a gifted policy, and this strategy does not require any additional cash outlay from the donor.

Transferring Ownership of a Policy to a Charity

Rather than naming a charity as the beneficiary, you could transfer ownership of an existing policy to a charity, giving them immediate control of the contract. The charity could then name itself as the beneficiary and receive a tax-free payout when the donor dies. If the policy has cash value, the charity could surrender the policy for the cash value immediately. This option also allows the donor to take an immediate charitable contribution tax deduction.

Charitable Giving Riders

Charitable giving riders are another option. These riders, which can be attached to policies, pay a specific percentage of the policy's face value to a qualified charity chosen by the policyholder. They usually come at no additional cost and often do not reduce the cash value or the death benefit of the policy. However, they typically require the purchase of a high amount of protection to use them.

Business Expense Deductions for Life Insurance

While life insurance premiums are generally not tax-deductible, there are specific scenarios where you might be able to claim a deduction. For example, if you are self-employed, you can offer life insurance policy coverage as an employee benefit, in which case the premium payments could be tax-deductible depending on your business classification status. Additionally, if the beneficiary of your policy is a charitable organization, the premiums could qualify for a charitable deduction.

Frequently asked questions