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 life insurance can be considered a business expense and qualify for tax deductions. For instance, if you're a business owner offering life insurance as an employee benefit, you can usually deduct the premiums as a business expense, provided the business isn't the beneficiary of the policy. Additionally, if the life insurance policy is tied to alimony agreements from before 2019, the premiums may also be deductible. Consulting a tax professional is advisable to determine the specific circumstances under which life insurance can be treated as a business expense for tax purposes.

Life insurance for self-employed individuals

Self-employed individuals can purchase life insurance to provide financial protection for their families in the event of their death, helping to replace lost income and cover expenses. There are several options for life insurance for the self-employed, including term, whole, and universal life insurance, each with unique benefits.

Types of Life Insurance for Self-Employed Individuals

Term Life Insurance

Term life insurance covers you for a specified number of years, often 10, 20, or 30 years. If you die within the coverage term, the insurance company pays a death benefit to your beneficiaries. Term life insurance is generally less expensive than permanent insurance and can be renewed when it expires, although the premium may increase.

Whole Life Insurance

Whole life insurance covers you for your entire life as long as premiums are paid. In addition to the death benefit, whole life insurance can also build cash value that you can borrow against or withdraw. However, doing so may reduce the death benefit or cause the policy to lapse.

Universal Life Insurance

Universal life insurance also covers you for your whole life, with more payment flexibility. Your initial payments build up cash value, and you may be able to change the amount you pay each year and use the cash value to help pay premiums as you age. Similar to whole life insurance, there may be consequences for borrowing against the cash value.

Purchasing Life Insurance as a Self-Employed Individual

When purchasing life insurance as a self-employed individual, it is important to assess your needs, compare rates, and choose a reputable provider. You will typically need to provide basic information such as proof of identity, proof of residency, and proof of income. Health information and medical records may also be required.

Tax Implications of Life Insurance for Self-Employed Individuals

Life insurance premiums are generally considered personal expenses and are not tax-deductible. However, if you own a business that offers life insurance as an employee benefit, the premiums may be deductible as a business expense, provided that neither the business nor the business owner is a beneficiary of the policy.

Tax-deductible business expenses

As a business owner, you can deduct a variety of expenses from your taxable income. These expenses must be both ordinary (common and accepted in your industry) and necessary (helpful and appropriate for your business). Here are some of the most common tax-deductible business expenses:

Employee compensation and benefits

Employee salaries, wages, bonuses, and commissions are typically tax-deductible. Additionally, fringe benefits such as health insurance, sick pay, vacation pay, group-term life insurance, dependent care assistance, and educational assistance are also deductible.

Legal and professional fees

Fees paid to professionals such as attorneys, accountants, bookkeepers, and tax preparers are deductible when they are necessary and directly related to your business. This includes legal and accounting fees incurred during business formation, such as fees for incorporating your business.

Travel, meals, and entertainment

Business-related travel expenses, including transportation, lodging, meals, and entertainment, are generally tax-deductible. However, it's important to note that entertainment expenses are no longer deductible starting with tax years after 2017. Make sure to keep detailed records of your business trips, including dates, locations, and business purposes.

Business use of your vehicle

If you use your vehicle for business purposes, you can deduct the associated expenses. You can choose between the standard mileage rate method or the actual expense method for deduction. The standard mileage rate for 2023 is $0.655 per mile. Keep a log of your business trips, including dates, miles driven, and purposes.

Business insurance

Premiums paid for various types of business insurance are tax-deductible. This includes property insurance, liability insurance, malpractice insurance, workers' compensation insurance, auto insurance for business vehicles, and business interruption insurance.

Advertising and promotion

Costs associated with advertising and promoting your business are typically deductible. This includes expenses such as hiring a designer for your business logo, printing business cards or brochures, purchasing ad space, sending cards to clients, launching a website, and running social media marketing campaigns.

Office expenses and supplies

Expenses related to your office space, such as rent, utilities, repairs, and depreciation, are deductible. Additionally, office supplies such as paper, pens, and furniture are also tax-deductible.

Interest on business debts

Interest paid on business-related debts, such as loans or credit card interest, is generally tax-deductible. This includes interest on loans from shareholders, as long as there is a valid business purpose and written documentation.

Taxes and licenses

Various taxes and licenses related to your business are deductible. This includes personal property taxes, real estate taxes on business property, sales and excise taxes on business-related purchases, and fuel taxes.

Depreciation on equipment and machinery

You can deduct the cost of leasing or renting equipment and machinery for your business. Additionally, you can claim depreciation on these assets, which allows you to spread out the deduction over the expected life of the asset.

Startup and organizational costs

While not technically a tax deduction, business startup costs are seen as a capital expense by the IRS. This means that you can amortize these expenses over several years, accurately assessing your business's profitability year over year.

It's important to note that there are specific rules and restrictions for deducting certain expenses, and not all businesses will qualify for every deduction. Additionally, some expenses may only be partially deductible, and there are certain non-deductible expenses, such as federal income tax payments, penalties, and fines for breaking the law, and political contributions.

Life insurance as a business owner

As a business owner, you may be wondering if life insurance is considered a business expense. The short answer is: it depends. While life insurance premiums are typically not tax-deductible, there are specific scenarios where they may be deductible. Here are some things to consider:

Types of Business Life Insurance

Firstly, let's understand the different types of business life insurance policies:

• Executive Bonus Life Insurance: This is a type of policy where the business bonuses an employee to pay the premiums on a life insurance policy that will benefit their family in the event of their death. The family can use the tax-free death benefit to replace the lost income of the executive.
• Key Person Life Insurance: This type of policy provides financial support to a business in the event of the death of a key employee. The business receives a lump sum payment from the insurance company, which can be used to cover expenses such as lost revenue, hiring and training new employees, or paying off loans.
• Buy-Sell Agreement Funding: This is a legally binding contract between business partners that outlines how the ownership of the business will be transferred in the event of one partner's death. The agreement is typically funded through business life insurance policies, with each partner purchasing a policy on the other's life.
• Business Loan Collateral: In some cases, a life insurance policy may be used as collateral for a business loan. The interest portion of the premiums on this type of policy may be deductible as a business expense.
• Group Term Life Insurance: This type of insurance provides coverage for company employees and is often offered as a pretax deduction in employee benefits packages. The premiums paid for this type of insurance, up to $50,000 per employee, are usually eligible for pretax deductions.

Corporate Structure Matters

The deductibility of life insurance premiums as a business expense can also depend on the corporate structure of your company.

• C-Corporations: According to the Internal Revenue Code, life insurance owned by a C-corporation is considered a non-deductible expense. This applies regardless of whether the corporation owns the policy or is the recipient of the benefits.
• S-Corporations: Life insurance premiums are only deductible if the S-corporation offers life insurance as an employee benefit. The premiums must be listed as wages if the policy covers key employees, and any coverage over $50,000 must be reported as wages on the employee's W-2 form.
• LLCs: While the IRS allows LLCs to deduct most insurance premiums as a business expense, life insurance premiums are generally not eligible. However, if you own an LLC and are paying life insurance premiums for your employees, these premiums may be deductible, as long as the LLC does not benefit from the coverage.

Important Considerations

When considering life insurance as a business expense, keep the following in mind:

• Beneficiary Matters: If you (the business owner) are the beneficiary of a policy owned by an employee, the premiums you pay are generally not deductible as a business expense.
• Notice and Consent: When taking out life insurance on an employee, it is important to ensure that the employee is notified in writing and provides written consent. The employee should also be informed that the business will be a beneficiary of any proceeds payable upon their death.
• Alimony and Divorce Agreements: Life insurance premiums may be deductible if you have an alimony or divorce agreement from before 2019 that requires you to pay for life insurance on your ex-spouse.
• Donating Policy to Charity: If you donate your life insurance policy to a charity, any premiums you pay after the date of the donation may be tax-deductible.
• Consult a Professional: The rules and requirements for deducting life insurance premiums as a business expense can be complex and vary depending on your specific circumstances and tax status. It is always advisable to consult with a qualified tax professional or accountant before claiming any deductions related to life insurance premiums.

Life insurance for employees

Life insurance is an important benefit that employers can offer to their employees. It can provide financial protection for employees' families in the event of their death. While it is not mandatory, it can be a valuable addition to a benefits package.

Types of Life Insurance for Employees

There are two main types of life insurance that employers can offer: term life insurance and permanent life insurance. Term life insurance provides coverage for a specific period, usually the duration of employment, while permanent life insurance offers lifelong coverage. Permanent life insurance also has a cash value component, allowing employees to build savings for the future.

Advantages of Life Insurance for Employees

One of the main advantages of life insurance through an employer is convenience. Employees can easily enrol during open enrolment or when they first join the company, without needing to find their own provider. Additionally, employer-sponsored life insurance often does not require a medical exam, saving time and potentially expanding coverage to those who may require high-risk insurance.

Another benefit is the potential for group discounts and lower premiums. Employers often cover a large portion, if not all, of the premium payments, reducing the out-of-pocket cost for employees. This is especially advantageous for those who may struggle to afford individual coverage.

Disadvantages of Life Insurance for Employees

One drawback of employer-provided life insurance is that the coverage amount is usually tied to the employee's salary and may not be as high as an individual policy. Additionally, coverage typically ends when an employee leaves the company, and the policy features are generally predetermined by the employer, offering limited customisation.

Tax Implications of Life Insurance for Employees

Life insurance benefits of $50,000 or less are generally not taxable for employees. However, if the benefits exceed this threshold and the employer pays any portion of the premium, the IRS considers this taxable income, increasing the employee's tax liability.

Considerations for Employers

When deciding whether to offer life insurance to employees, employers should be aware that it can be a valuable recruitment and retention tool. It demonstrates a commitment to employee well-being and can boost productivity by providing financial security for employees and their families.

However, it is important to note that life insurance premiums are typically not tax-deductible for businesses, except in specific situations. For example, if the business is classified as an S corporation or LLC, and the life insurance is offered as an employee benefit through a group plan, the premiums may be tax-deductible.

Life insurance for alimony agreements

Life insurance is rarely a contested issue in divorce cases and is often overlooked. However, it is an important consideration, especially if there are children involved.

Protecting Alimony and Child Support

If you are receiving alimony or child support, you can protect yourself by taking out a life insurance policy on your ex-spouse. This ensures that, in the event of their death, you will still receive the financial support you need. The benefit amount should be high enough to replace your income from alimony or child support until your youngest child is grown.

Who Pays the Premiums?

If you are the recipient of alimony or child support and cannot rely on your ex-financially, it is advisable to own the policy and pay the premiums yourself. This gives you control over the policy and ensures that, if premiums aren't paid, the policy won't lapse.

Choosing the Right Type of Life Insurance

Term life insurance is often the best option for divorcees as it is separate from any other assets. Whole life insurance, on the other hand, may be considered a joint asset due to its cash value.

Beneficiaries

In the case of spousal support, the supported spouse should be the beneficiary. For child support, the children may be named as beneficiaries, but this raises additional questions. For example, if the policy is paid to the children, will it be put into a trust?

Monitoring the Policy

If your ex-spouse owns the policy, you will want a mechanism in place to monitor it. You could request duplicate statements, an automatic notification from the insurance carrier each time a premium is paid, or a phone number to verify payment.

Cancelling the Policy

It is important to clarify in the settlement agreement when the obligation to carry the policy ends. While it may seem obvious that the policy should terminate when support payments end, spelling this out explicitly avoids any potential confusion.

Choosing an Insurance Company

As the supported spouse, you may want to choose a well-established and reputable insurance company to ensure that the policy is still in place if your circumstances change.

Life Insurance and Business Expenses

Life insurance premiums are generally not tax-deductible for self-employed individuals or business owners. However, there are a few exceptions. If you are a business owner, you can offer life insurance as an employee benefit, in which case the premiums may be tax-deductible, depending on your business classification status. Additionally, if you have spousal or child support agreements made before 2019 that include life insurance premiums, these may be deductible.

Frequently asked questions