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How Life Insurance Premiums for the Self-Employed Are Taxed
The self-employed individual can deduct some life insurance premiums, but not others. It will be important to consult a tax professional to be sure to claim the right deductions, not run afoul of the law, and at the same time get all the tax breaks the business is entitled to.
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Life Insurance for the Business Owner
The self-employed individual will not be able to deduct premiums paid for their own life insurance or that of family members.
That is, after all, not a business expense but a benefit to them. They may be able to deduct family health insurance premiums; but because everyone’s situation is different, the accountant or CPA should be consulted.
Life insurance planning for a business will be based in part upon the company structure.
The self-employed individual can tally up their own personal life insurance need quickly using the simplistic, but quite-enough-for-most-people method called D.I.M.E. and can apply it for both business and personal assessments:
- Debts – What debts could be paid off immediately with an insurance payout, leaving room on the business or personal balance sheet for the survivors to operate?
- Income – If a family depends on revenue from the business in the form of the key person’s salary, this amount should be factored in. How long will it take that family to recover from the loss of the income? How many years of support will the children need?
- Mortgages – Could the policy be used to pay off outstanding mortgages on the business’ (or family’s) balance sheet? The survivors would then be responsible only for the taxes, a much lighter burden.
- Expenses – These may be transitional expenses to keep the business operating despite the sudden loss of a key player, or final expenses for the deceased.
If additionally, there are partners or key employees who receive a separate tier of benefits, the business may be covered by yet other categories of life insurance products: the premiums for some of these will be taxable; for others, not.
Life Insurance for the Employee
If a business has employees and offers them group life insurance as a benefit of employment, the business may deduct those premiums, up to the first $50,000 in life insurance coverage for each employee.
Whether employee insurance is calculated as a flat amount for each employee, or as a percentage of annual salary, the employer-paid premiums for the first $50,000 of group life insurance are tax-deductible to the employer.
If the company group plan offers policies greater than $50,000, the premiums paid for the additional amount are considered by the IRS to be a taxable benefit to the employee.
If the company covers employees’ dependents, it can deduct the premiums for the first $2,000 in life insurance face value for each dependent. Beyond the first $2,000, the tax burden shifts to the employee.
The same rules apply if the company offers employer-paid individual life insurance to a few executives or some other class of employees at the firm. In this case, the employer pays the premiums, but the employee owns the policy.
And if the employee leaves the company they can assume payment of the premiums and retain the policy.
Up to the first $50,000, the company can deduct the premiums, and the employee benefit is free of taxes to the employee. If this employee later leaves and takes over the premium payments, the full tax deduction would then go to the employee.
Life Insurance for the Business
Group life and individual life insurance premiums are discussed above: in general, the premiums paid by an employer are tax-deductible to the employer as a business expense – except when the business is itself the beneficiary of the policy.
The employer is not entitled to a tax deduction for premiums on the other types of life insurance it is likely to carry. Some of these are “company owned life insurance” or COLI. These other types of business life insurance are:
- Key Employee (Key Person) insurance
- Stock Redemption or Entity Purchase Agreement
- Split Dollar insurance
Because the business will have purchased Key Employee, Stock Redemption, and Split Dollar insurance plans as a benefit to itself, the premiums it pays for them will not be tax deductible.
Key Employee insurance helps a business cover the costs associated with losing a key operational player.
It might be used to pay costs associated with finding that person’s replacement and perhaps keeping the business running in crisis mode.
If the business is still small enough that the owner is the key employee, life insurance might be part of the formal business continuity plan.
Life does happen. A business with employees bears responsibility for the lives of others and should be able to survive the loss of any single person.
Stock Redemption Agreements are usually used in partnerships, and may also be referred to as Buy-Sell Agreements. Their function is if one partner dies the others have the cash to buy out their share of the business.
Split Dollar is a strategy whereby employer and employee share the cost of premiums for a permanent, cash-value life insurance policy. This strategy is usually used as an executive bonus or retention tool for a high-level employee.
A business owner may additionally purchase insurance to guarantee a loan with a bank or other lending institution.
Tax Treatment of Life Insurance
A tax accountant will be the best advisor on matters of taxation for a business. Business tax rules and regulations change quickly.
It is the job of the financial professional to keep their clients abreast of important changes at annual or bi-annual touch points.
As a self-employed individual also must make sure they are keeping themselves up to date by making sure these topics are discussed and revisited regularly.
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