Is Life Insurance a Business Expense for the Self-Employed?

Life insurance may often be considered a valuable investment in the future financial well-being of your family and loved ones, with multiple policies and features that help you accumulate a cash value and help secure a death benefit payable to your named beneficiary.

In general, life insurance premiums are rarely, if ever, a tax-deductible expense.* In effect, a self-employed person cannot deduct the cost of their coverage from their income before calculating the amount subject to taxation.

While a qualified tax adviser can provide further information, the IRS normally treats life insurance as a personal expense rather than an eligible business deduction. It prevents self-employed professionals from claiming this as a cost of running their business.

As we have noted, the tax authority usually classifies any life insurance policy, including whole life insurance for pre-existing conditions, as an item of personal expenditure; you cannot typically reduce your tax obligations by paying insurance premiums or contributing optional additional amounts into a life coverage policy.

Registered businesses can purchase life insurance as an employee benefit and deduct the cost from their profits, but the regulations around this area are fairly strict. For example:

• A sole trader or freelance professional cannot claim that life insurance premiums are a business cost as the benefits offered by their policy directly benefit the individual, not the business.
• Business owners who purchase whole life insurance for parents, where the named beneficiary is an immediate relative (such as a spouse),may be unable to deduct the premiums. That is because, again, the individual or their partner may be the end beneficiary.
• Employees who receive life coverage as part of their remuneration package may be subject to taxation if the death benefit is valued above $50,000.

A scenario where life insurance premiums may be eligible as a tax-deductible outgoing is where a business offers the insurance as an employee benefit. Companies might, for example, provide health insurance and life coverage or offer their workforce these perks with conditions, such as remaining with the organization for a minimum period.

Business owners who purchase life insurance policies typically cannot claim the cost of the premiums as an expense for any policy that directly or indirectly benefits them. This rule also applies to insurance policies where the owner is the insured party, a beneficiary, or the beneficiary is a partner or spouse.

Employees offered coverage with a benefit above $50,000 may also be exposed to a proportional tax levy.

There are many other potential tax advantages of life insurance, such as:

• Tax-Free Death Benefit: The primary tax advantage of life insurance is that in almost all situations, the death benefit paid out to beneficiaries – whether it’s your spouse, children, charity, or others - upon the insured's death is generally income tax-free. This means that the beneficiaries receive the full amount of the death benefit without having to pay federal income tax on it.
  
• Tax-Deferred Growth: For permanent life insurance policies with a cash value component, such as whole life or universal life, the cash value grows tax-deferred. This means that you don't have to pay income tax on the growth of the cash value as long as it remains inside the policy. This tax-deferred growth allows your cash value to accumulate more quickly over time. Generally, taxes are only due when you take money out of the policy that is in excess of premiums paid into the policy.
  
• Tax-Free Withdrawals and Loans: Policyholders can access the cash value of their permanent life insurance policy through withdrawals or loans subject to policy provisions. Generally, withdrawals up to the amount of premiums paid into the policy are considered a return of basis and are not subject to income tax. Policy loans are also typically tax-free and not considered taxable income, although they may reduce the death benefit if not repaid.
  
• Tax-Free Exchanges: Policyholders can exchange one life insurance policy for another or for a different type of annuity through a IRS Section 1035 exchange without triggering a tax liability. This allows individuals to change policies or annuities without incurring taxes on the gains.
  
• Estate Tax Benefits: Life insurance can help minimize estate taxes by providing liquidity to pay estate taxes. If you have a large estate, you should consult a tax specialist to see how life insurance can help with estate taxes.
  
• Final Expenses: Life insurance can help pay for any final expenses associated with your death, whether it is medical bills that have accumulated or the cost of a funeral.
  
• Charitable Giving: Life insurance can be used as a tax-efficient way to make charitable donations. By naming a charity as the beneficiary of a life insurance policy, the death benefit can be excluded from the insured's estate for estate tax purposes, and the charity receives the full amount tax-free.

Overall, life insurance can offer several tax advantages that can help policyholders build wealth, protect their loved ones, and minimize taxes both during their lifetime and at the time of death.