Is my life insurance deductible on schedule c?

In a general sense, life insurance premiums are not deductible on Schedule C or in any other manner. Of course, there can be exceptions to everything, and there are some when it comes to this subject.

Schedule C is the IRS form that a small business uses to report its profit and loss from doing business.

Property insurance, fire insurance, and vehicle insurance are deductible items on Schedule C, but not life insurance premiums. The acting principle of law is that even if a business owns a life insurance policy, it is still not a deductible item.

The IRS Publication 502, under the insurance premiums section, “Insurance Premiums You Can’t Include, life insurance premiums are not allowed for deduction.

The reasoning on this issue goes back quite a few years when it was deemed that life insurance is mainly a benefit to widows and orphans and that the benefits that are paid to them should be income tax-free.

The reasoning goes on to say that if the premiums were to be deductible, then the death proceeds ought to be taxable to the beneficiaries.

Business-owned life insurance, which would be shown on Schedule C if it were to be deductible is not deductible under IRS Section 502 because the business would be named the beneficiary on most instances.

Key-Man life insurance, deferred compensation plans, and buy-sell planning would all fall into the non-deductible category.

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An Example of The Ramifications of Deductible Premiums

If the illustration of allowing deductible premiums for life insurance were to be followed through the course of its “shelf life,” and if the business could deduct life insurance premiums as a business expense, there would be a short-term advantage of the deduction from income taxes.

Just for the sake of the example let us assume that the business is in a 25 percent tax bracket. To follow through until the death claim would be paid, then the logic would decree that the death benefit would have a 25 percent tax to the beneficiary.

In an example of a $100,000 death benefit, there would be a $25,000 tax to the beneficiary, which defeats the purpose of the insurance.

But There Are Exceptions

The exception to the rule is always a bit controversial, that is until the concept is understood. There are some arrangements when the “premiums” for business sponsored life insurance are deductible. These are legitimate situations and fully backed by the law of the land.

–Executive Double Bonus

The executive double bonus plan falls under Section 162 of the IRS code. This is a plan where a key executive is given a perk in the form of a life insurance plan for his use and for the purpose of protecting his beneficiaries should he die.

The employer credits the amount of the premium to the executive and deducts the bonus as they would any other cash bonus.

The only difference is that the bonus amount is directed to the insurance company to purchase the policy.

Since the bonus to the executive is income to him, he will be taxed on the amount of the bonus and deducted by the employer. The employer can then choose to bonus the amount of the perceived tax to mitigate the added expense.

The bonus on the tax will be taxed, but the overall benefit mitigates the small amount of money that is taxed, and the executive receives a nice benefit.

–Life Insurance That is Purchased Inside of a Qualified Plan

If life insurance is purchased inside of a qualified plan, the premiums are included as a part of the contributions to the plan. The employer would be able to deduct the contributions to the portion going to the life insurance just as they could deduct plan contributions going to investments withing the plan.

The employee, however, will have to pay a term insurance charge for the economic benefit received from the insurance. The government has rate tables called the PS 58 table charges.

These rates are minor in amount, and the employee pays a very small charge for the privilege of having life insurance that he or she may not have otherwise been able to procure.

Since the life insurance is being purchased with before-tax dollars, the amount of life insurance purchased will be more than if those same dollars were after-tax dollars. There are rules to follow, such as the percentage of life insurance in the plan cannot exceed certain levels.

If the participant who is purchasing the life insurance within the qualified plan dies while still participating, the amount of the death benefit that is more than the cash value will be received by the beneficiary tax-free. The amount of the cash value that exceeds the basis of the cash value will be taxable.

The Magic of The Permanent Life Insurance Policy

The death benefit of a life insurance policy is not subject to federal or state income taxation unless the policy has been purchased for gain from an insured. This is called a “transfer for value,” and this sort of transaction does not happen all that often.

–The Cash Value Accumulates on a Tax-Deferred Basis

The inside buildup of cash in a permanent life insurance policy is not taxed as ordinary income, unless the policy is surrendered, or cashed in.

The amount that would be taxed is any excess over what the policyholder had paid in.

–Policy Loans Are Not Subject To Income Taxes

Policyowners can borrow the money that accumulates in the cash value of their life insurance policy. As long as the policy remains in force, there are no taxable events that would trigger a tax.

Some permanent life insurance policies can be “over funded” for the sole purpose of cash accumulation, and when the policyholder is ready to retire, calculations are made to draw the retirement funding through policy loans. The result is a tax-free retirement.

In Conclusion

Life insurance premiums are mostly not deductible on the Schedule C of a company’s tax return. Two exceptions are the 162 Executive Bonus Plan, and the purchase of life insurance inside of a qualified plan, such as a defined benefit plan, defined contribution plan, and a 401 k plan.

For most of the population of individuals and businesses, the tax deductions not available for premiums, but there are other tax advantages outweigh any benefit that could be gained by deducting the premiums.

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