Life Insurance Deductible
The tax ramifications and deduction entitlements of life insurance premiums can be complex. When undertaking estate and asset planning, it’s always prudent to seek guidance from a tax professional.
Is Life Insurance Deductible from Income Tax?
Premiums paid on your life policy are not tax deductible from your income. The IRS clearly stipulates what items can be deducted in Schedule A of Form 1040 in publication 502, Medical and Dental Expenses. The publication states “you may not deduct premiums for life insurance“.
This is in contrast to some medical health premiums for policies such as medical care or qualified long-term care which are tax deductible.
Even if you’re a small business owner, your personal life insurance premiums cannot be deducted from the business income for tax purposes. Even though a small business can potentially collapse without life coverage being taken out on the owner, the policy and business are deemed separate.
Life Insurance Deductible & Payroll
An employer can purchase group term life insurance (GTLI) on behalf of its employees and provide this as a benefit under the employment contract. Employees can purchase additional coverage on the GTLI through the employer and pay the additional premiums via payroll deduction. These are called Voluntary Payroll Deduction (VPD) programs. The employer simply deducts the additional cost from the employees’ wages each week.
For tax purposes, if the group benefit reaches over $50,000 for a certain employee, the excess must be reported as income to the IRS, less any after-tax premiums the employee has paid. The additional value is worked out by a formula under the IRS regulations, taking into account the employee’s age and the number of months provided by the coverage.
For example, a 35 year old employee has a GTLI valued at $80,000 and has not paid any premiums:
The excess is $30,000, divided by 1,000 = 30 x $0.9 (the age appropriate value) x 12 months = $32.40 (the amount of premiums paid by the business for the excess of $30,000 coverage, which is to be added to the employee’s W-2 as income). The IRS determines the values for calculating the additional income (these values do not have any correlation to how much an employer has actually paid for the extra insurance).
Insurers have begun to target employers to make sales presentations to their staff. Employees are offered individual policies which can be paid using the employer’s payroll deduction system. Basically, the employer uses your after-tax dollars to pay for your individual premiums. It’s simply a convenient way of having your own life insurance policy without having the burden of writing your own checks.
Unlike Accidental Death & Dismemberment Group policies, these plans are portable because they are individual policies (even though they are set up for a group). This means your coverage continues if you leave your job for whatever reason.
If you have health issues, a group payroll deduction plan is easier to obtain. Insurers of these plans generally have relatively modest underwriting (if any).
Business Deductions
Ordinary and necessary insurance costs are deductible as a business expense if, according to the IRS, the expense is for your trade, business or profession.
This does not include personal life insurance premiums. If you’re self-employed, you cannot deduct your individual premiums as a business expense.
However, according to IRS Publication 535, depending on your state, you may be able to deduct unemployment contributions if they are defined as taxes under state law. If you qualify, you may also deduct medical, dental and qualified long-term care premiums for yourself, your spouse and your dependents.
IRS Publication 535 also states you can deduct life insurance premiums covering your officers and employees provided you are not a beneficiary under the contract (whether directly or indirectly).
You are deemed an indirect beneficiary if the policy owner is required to pay back a loan owing to you from the insurance proceeds.
For partnership life insurance contracts, you are deemed to be an indirect beneficiary if the policy covers your life and names your partner as beneficiary to encourage them to keep their investments in the partnership. Premiums on these policies are therefore not deductible.
IRS Publication 334 allows deductions for group-term life insurance premiums which you provide as a benefit to your employees.
The publication states that premiums for a life insurance policy taken out on you or on a person with a financial interest in the business for the purpose of securing or protecting a business loan are non-deductible.
Corporations who have taken out COLI (corporate-owned life insurance) on their employees (usually senior executives) generally cannot deduct any amounts paid on such policies if it’s part of a plan to borrow the increased cash value systematically, unless the company meets the safe harbor requirements.