It is a common misconception that running a business entitles owners to deductible life insurance premiums. But that’s not always true.
Unlike the strict rules for individuals, it’s true that businesses have a bit more leniency with tax-deductible life insurance premiums. But only in very specific cases are they deductible as a business expense. In all other cases, deducting those premiums can lead to costly consequences.
When can businesses deduct life insurance premiums as a business expense?
Businesses must meet a very specific set of qualifications for these premiums to be a deductible business expense. And even those rules have their own caveats.
These are the criteria that businesses must meet:
- They must be classified as either an S Corporation or an LLC.
- The insureds must be employees or corporate officers under a group policy.
- The company CANNOT be named as the beneficiary of the group life insurance policy.
- Only the first $50,000 of premiums paid are deductible. Anything after that is no longer deductible.
For C Corporations, premiums aren’t a deductible expense if shareholders have policies through the company and the company is the beneficiary. In this situation, the life insurance benefit is also a taxable fringe benefit.
Self-employed people and freelancers are not eligible to deduct their life insurance premiums as a business expense either. They fall under the same considerations as individual policies.
Are key person life insurance premiums a deductible as a business expense?
Key-person life insurance exists to help businesses protect themselves in the event that an integral member dies. This can be in place for a founder or someone with a specific set of skills that would hurt your business if they weren’t there.
In cases where the business is the beneficiary, the premiums from a key person policy are not tax-deductible as a business expense.
Now, there is an exception to this rule. If the premiums are part of the employee’s taxable income, then the premiums from a key person policy are deductible as a business expense. In this case, the employee is the beneficiary, which makes it eligible for deduction.
Are buy-sell agreements a deductible as a business expense?
A buy-sell agreement operates along similar lines as key person insurance. In this case, it allows co-owners of a business to protect themselves in the event that one owner leaves or dies.
These agreements can be funded with life insurance policies, either purchased individually by each co-owner or by the company itself. This way if a co-owner dies then the others will receive the benefits from that policy.
Since the business is the beneficiary of a buy-sell agreement, then those premiums are not a tax-deductible business expense. Unlike a key person policy, buy-sell agreements funded through life insurance do not carry any exceptions for deductions.
What are the consequences of deducting life insurance premiums as a business expense?
Even if you know that life insurance premiums usually aren’t deductible, you may think that writing them off as a business expense isn’t a big deal. In fact, it’s a huge deal and it stands to hurt your employees the most.
Deducting your life insurance premiums as a business expense makes the benefits on the policy become taxable. If you do this with a large group policy, beyond the $50,000 of coverage available for S Corps and LLCs, this means that all of your employees will get saddled with a tax on their benefits. This means a large chunk of your employees’ otherwise non-taxable benefit is unavailable to them.
For this reason, it is of the highest importance that you understand when you should and shouldn’t deduct premiums. Or your employees and their beneficiaries will get a rude awakening when they try and collect their benefits.
Still, have eligibility questions?
If you find yourself with further eligibility questions, it’s best to reach out to a professional. Navigating complicated tax codes that change from year to year can be confusing and a financial professional can help you find the right way forward.