Life Insurance: A Legitimate Business Expense?

Life insurance premiums are generally not considered tax-deductible, as the Internal Revenue Service (IRS) categorises them as a personal expense. However, there are specific scenarios where life insurance may be claimed as a business expense and is thus tax-deductible. For instance, if you are a business owner, you can deduct life insurance premiums paid on behalf of your employees or corporate officers, as long as the company is not a policy beneficiary. Additionally, if the beneficiary of your policy is a charitable organisation, the premiums could qualify for a charitable deduction.

Life insurance for self-employed individuals

Understanding Your Needs

The first step is to assess how much coverage you need. This includes evaluating your existing life insurance policies, if any, and determining the financial needs of your family or beneficiaries. A detailed analysis using the DIME method – which accounts for debts, income, mortgage, and education – can help estimate the required insurance amount. Alternatively, experts recommend setting the benefit at 10 to 15 times your annual income. If your income fluctuates, consider averaging it over the past five years or using data for similar occupations.

Additionally, consider if you need coverage for business debts and expenses. This could include business credit cards, loans, equipment, outstanding invoices, and regular expenses like rent and utilities. If you intend to keep your business running during a transition period, you may want to increase your coverage to account for operational expenses.

Types of Life Insurance Policies

There are two main types of life insurance policies: term life insurance and permanent life insurance. Term life insurance covers you for a specified number of years, often 10, 20, or 30 years. If you pass away within the coverage term, your beneficiaries receive a death benefit. However, if you live beyond the term, the policy expires without any payout. Term life insurance is generally less expensive and may offer the option to renew, although premiums may increase.

Permanent life insurance, on the other hand, remains in force as long as you continue paying premiums. It includes whole life, universal life, and variable life policies. These policies accumulate cash value, against which you can borrow. However, any unpaid loan amount at the time of your death may be deducted from the death benefit. Permanent insurance is typically more expensive, but the cash value can be useful during income fluctuations.

Choosing a Provider

When choosing a provider, it's important to compare multiple options and consider factors beyond just the premium price. Research the financial health and customer service ratings of different insurance companies. You may also benefit from working with a qualified insurance agent who can assist in calculating your coverage needs, choosing the right policy type, and navigating the application process.

Special Considerations for Self-Employed Individuals

For self-employed individuals, it's essential to recognize that life insurance premiums are generally not tax-deductible. The IRS considers these premiums to be non-deductible personal expenses. 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 policyowner is the beneficiary.

Additionally, self-employed individuals should be aware of other insurance options like critical illness insurance, which can provide coverage for serious, life-threatening illnesses. This type of insurance complements health insurance and can help protect your quality of life, giving you the freedom to use the money as needed during recovery.

Final Thoughts

While purchasing life insurance as a self-employed individual may seem complicated, understanding your needs and the different policy options can help you make informed decisions. Remember to assess your financial situation, compare multiple providers, and seek expert advice when needed to ensure you have the right coverage for yourself and your loved ones.

Life insurance as a business expense

Life insurance premiums are generally considered a personal expense and are therefore not tax-deductible. However, there are specific scenarios where life insurance can be claimed as a business expense and may be tax-deductible.

When Life Insurance Can Be a Business Expense

If you are a business owner, there are a few instances where you may be able to claim life insurance as a business expense:

• Employee benefit: If you offer life insurance as an employee benefit, you may be able to deduct the premiums as a business expense. This typically applies to group life insurance policies and not if you are self-employed and paying for your own policy.
• Business structure: The business structure can also determine if life insurance is tax-deductible. For example, in the US, S corporations and LLCs can deduct life insurance premiums as a business expense if certain criteria are met.
• Key person insurance: If you take out key person or key man insurance to cover essential employees, this may be considered a business expense. However, the company must not be a direct or indirect beneficiary of the policy.
• Alimony or child support agreements: If you have an alimony or child support agreement made before 2019 that includes life insurance premiums, these may be deductible.
• Charitable beneficiary: If a charitable organization is the beneficiary of your policy, the premiums may be tax-deductible.

When Life Insurance Is Not a Business Expense

It's important to note that there are also several situations where life insurance would not be considered a business expense:

• Self-employed individuals: In most cases, self-employed individuals cannot deduct life insurance premiums as a business expense, even if they are paying for health insurance.
• Spouse as an employee: If your spouse is an employee of your company and their policy pays out to you, this would typically disqualify you from claiming the premiums as a business expense.
• C corporations: In the US, C corporations are prohibited by the IRS from taking any type of deduction on life insurance premiums.
• Beneficiary status: You cannot claim life insurance as a business expense if you or your company are the beneficiary of the policy.

Other Tax Implications of Life Insurance

While life insurance premiums are generally not tax-deductible, there are other tax implications to consider:

• Death benefit payouts: Death benefit payouts are typically not taxable, and beneficiaries will receive the full amount.
• Estate taxes: However, death benefits may be subject to estate taxes if the total value of the estate surpasses federal and state limits.
• Selling or surrendering a policy: If you sell or surrender a life insurance policy for cash, you may have to pay taxes on any amount that exceeds the total premiums paid.
• Withdrawing from a policy's cash value: Withdrawing money from a policy's cash value account may also be taxable if the amount withdrawn is greater than the total premiums paid.

In summary, while life insurance is typically considered a personal expense, there are specific scenarios where it can be claimed as a business expense and may be tax-deductible, particularly when offered as an employee benefit or in certain business structures. However, there are also situations where life insurance would not qualify as a business expense, and it's important to understand the tax implications of life insurance policies.

Life insurance and estate tax

Life insurance and death benefits are generally not taxable as part of the beneficiary's gross income. However, there are some cases where death benefits are taxed. For example, if the payout is structured as multiple payments, such as an annuity, the payments may be subject to taxes. If the policyholder has withdrawn money or taken out a loan against the policy, the amount withdrawn above the total of the premiums paid may be taxable. If the policyholder surrenders their policy, any amount above the policy's cash basis will be taxed as regular income. If an employer-paid plan pays out more than $50,000, it may be taxable according to the Internal Revenue Service (IRS). Finally, if the death benefits and the total value of the deceased's estate exceed the federal estate tax threshold, currently $12.92 million as of 2023, estate taxes must be paid on the amount over the limit.

Life insurance proceeds are taxable in the estate of the insured if the proceeds are paid to the insured's estate or if the insured retained any "incidents of ownership" in the policy. Incidents of ownership include outright ownership as well as certain rights less significant than ownership, such as the right to change the beneficiary of a policy and to borrow against a policy to pay premiums. To prevent estate tax on life insurance proceeds, the insured must avoid payment to their estate and incidents of ownership. This can be done by having another person or entity apply for and purchase a new policy on the insured's life, or by transferring all incidents of ownership in an existing policy to another person or entity. If an existing policy is already in place, the insured must survive three years from the date of the transfer to avoid estate tax.

For business owners, life insurance is generally not tax-deductible. Even if self-employed, premium payments cannot be subtracted from total income each year. However, business owners can offer life insurance policy coverage as an employee benefit, and in this case, the premium payments may be tax-deductible depending on the business classification status. C corporations, for example, cannot claim a life insurance business expense as the IRS prohibits any type of deduction on life insurance premiums. S corporations and LLCs can utilize a life insurance business expense, but there are stipulations. The company must offer a life insurance policy as an employee benefit via a group plan, and if the plan is only available to executives, the premiums must be reported as wages. Additionally, if the coverage reaches $50,000 or more, that amount must be listed as wages on the employee's W-2. Life insurance also cannot be deducted as a business expense if the beneficiary of the employee's policy is also the owner of the business, as in the case of a married couple running an S-corp.

Life insurance as a tax-deductible business expense

Life insurance premiums are typically not tax-deductible because the Internal Revenue Service (IRS) considers them an optional personal expense. However, there are specific scenarios where you might be able to claim a deduction.

When Life Insurance Can Be a Business Expense

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 types of businesses, including LLCs and S corporations. However, there are stipulations to qualify for this deduction. The company must offer a life insurance policy as an employee benefit via a group plan, and the business cannot be the beneficiary of the policy. Additionally, if the coverage exceeds $50,000, that amount must be listed as wages on the employee's W-2.

Alimony and Divorce Agreements

Life insurance premiums may also be tax-deductible in certain situations for alimony and separate maintenance agreements made before January 1, 2019. If a judge ordered either spouse to purchase life insurance as part of an alimony agreement, the payments and premiums may be tax-deductible. However, this deduction does not apply to policies purchased before the divorce or agreements enacted after December 31, 2018, due to changes introduced by the Tax Cuts and Jobs Act of 2017.

Charitable Donations

Another scenario where life insurance premiums can be tax-deductible is when the policy ownership is transferred to a charitable organization or the charitable institution is named as the beneficiary. In these cases, the premiums paid for term or whole life insurance are tax-deductible. This allows for tax benefits, as the smaller of the premiums or the policy's cash value may be eligible for a deduction.

Business-Related Premiums

Life insurance premiums may also be considered a deductible business expense in certain business-related scenarios. This includes situations where policies are used to fund buy-sell agreements, the business is contractually obligated to maintain a life insurance policy, or the employer takes out key person insurance.

While life insurance premiums are generally not tax-deductible for personal policies, there are specific circumstances where they can be treated as a business expense and qualify for tax deductions. Consulting with a tax professional or financial advisor can help determine if your life insurance premiums meet the criteria for any of these scenarios.

Life insurance and income tax

Life insurance premiums are typically not tax-deductible because the Internal Revenue Service (IRS) considers them an optional personal expense. However, there are specific scenarios where you might be able to claim a deduction.

When Life Insurance Is Tax-Deductible

If you meet any of the following circumstances, you might be able to claim a deduction for your life insurance premiums:

• Business expense: Life insurance is considered a business expense when an employer pays the premiums. 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 policy beneficiary, whether directly or indirectly. You can write off life insurance as a business expense on the first $50,000 of life insurance benefits for an employee on group life insurance coverage, as long as the amount is not part of their compensation.
• Alimony and other agreements made before 2019: The IRS allows life insurance premiums as a tax deduction in certain situations for alimony and separate maintenance agreements made before January 1, 2019. If a judge ordered either spouse to purchase life insurance as part of an alimony agreement, the payments and life insurance premiums may be tax-deductible. Policies purchased before the divorce, even if the ex-spouse remains the beneficiary, do not qualify for this deduction.
• Life insurance beneficiary is a charitable institution: A life insurance policy might also be tax-deductible if the policy ownership is transferred to a charitable organization or the institution is named the beneficiary. The premiums you pay for both term and whole life insurance are tax-deductible in these cases.

When You Have to Pay Taxes for Life Insurance

Although beneficiaries don’t typically pay taxes on death benefit proceeds, there are some situations where you do have to pay taxes for life insurance:

• Selling your own policy: If you sell your life insurance policy, the amount you get may be considered taxable income.
• Surrendering permanent life insurance for cash: If you surrender a permanent life insurance policy, you might pay taxes on the surrendered amount that's greater than the premiums you paid into the policy.
• Withdrawing from your policy’s cash account: If you withdraw money from your life insurance policy’s cash value account, you may be taxed on the withdrawn amount.
• Beneficiaries receiving death benefits through installments: When a beneficiary chooses to receive the death benefit through installments rather than a lump sum, any interest earned on the unpaid death benefit may be considered taxable income.

Other Tax Implications and Benefits of Life Insurance

While life insurance premiums are generally not tax-deductible, there are other tax-related aspects to consider:

• Death benefit taxation: The death benefit payout is usually not taxable, so your beneficiary will receive the full face value of the life insurance policy once a death claim is approved.
• Loans against cash value: Loans taken against the cash value of a life insurance policy are generally not taxable.
• Business-related premiums: Life insurance premiums may be considered a deductible business expense in certain scenarios, like when policies are used to fund buy-sell agreements, the business is contractually obligated to maintain a life insurance policy, or the employer takes out key person insurance.
• Estate tax considerations: While the death benefit is generally income tax-free, it may still be subject to estate taxes. Strategies like setting up an irrevocable life insurance trust can help mitigate this.
• Gift tax implications: If you're transferring a life insurance policy to someone else, be aware that this could trigger gift tax implications. The rules can be complex, so consult a tax advisor for guidance.
• Dividends: Some whole life policies pay dividends. While these are generally not taxable, different rules may apply if you receive them in cash. Consulting a tax advisor is recommended.

Frequently asked questions