Key employee insurance is an essential tool for many small businesses and is used to protect them from the loss of a key person due to death or disability. When considering key employee insurance, it is vital to understand both the tax implications as well as the IRS reporting requirements in the key man or corporate owned life insurance arena.
Key Man Insurance and Tax Deductions*
If you are like most business owners, you constantly look at smart ways to shield your company from any IRS tax burden. Hence, if you can protect your business with key employee insurance AND get a tax deduction for premium payments, buying key person insurance is a “no brainer”. However, as a general rule, all life insurance policies, including corporate owned life policies (with certain compliance, see below), are afforded special tax treatment from the IRS to encourage everyone to purchase life insurance. The incentive is that all death proceeds or death benefits are paid to a named beneficiary income tax free! So, with proper compliance key employee life insurance death benefits will be paid to your business tax free.
That is not to say that you are not allowed to deduct the premiums of corporate owned life insurance policies as an expense! However, if you choose to write-off the premiums, the proceeds or death benefits from the insurance policy will be taxable! Therefore, it doesn’t make real sense to write off a key employee life insurance premiums as business expenses. Any tax break your business will get from deducting key person insurance premiums will be negligible compared to the unnecessary tax bill on the death benefit payout of a key person life insurance policy.
Important Rules Regarding Corporate Owned Life Insurance*
In 2006, in an effort to eliminate corporate abuse, new IRS rules were passed in the The Pension Protection Act of 2006 which contains the Corporate Owned Life Insurance (COLI) Best Practices Act. The COLI Act includes regulations that have significantly impacted all Corporate Owned Life Insurance including key employee coverage that is purchased after August 17, 2006. Any key person insurance owned by a business, issued after August 17, 2006 may have death benefits that are subject to income taxation if certain mandatory requirements are not satisfied. Two of these requirements are that the key person must meet the guidelines defining a “key person” and the company must obtain written consent from the covered employee at the time the policy is purchased. There are also annual IRS reporting requirements. Failure to fulfill the mandatory IRS requirements will result in the taxation of life insurance policy proceeds. Be sure to get with your CFO or accountant on these requirements.
Summary
Key employee insurance provides valuable peace of mind and there are numerous advantages to purchasing this valuable protection. However, tax deductibility of premium payments for key person insurance is NOT one of them. In fact, key employee life insurance premiums should NOT be deducted as business expense because of the favorable tax treatment received from the IRS.
Furthermore, all Corporate Owned Life Insurance (COLI) policies, which include key employee policies, issued after August 17, 2006 must meet certain mandatory reporting requirements to avoid taxation of policy proceeds. We recommend a consultation with your CPA regarding these requirements. For questions or more information, CALL NOW at (877) 583-3955.
References and Links
- Free Key Employee Life Insurance Quote
- Key Employee Life Insurance Explained
- Should I Buy Key Person Insurance?
- Alternative to Key Man Insurance
* All of the above tax information is for information purposes only and is provided to explain the basic tax treatment of life insurance based on the Internal Revenue Code. Any individual or entity considering any life insurance policy should consult with their own CPA or tax/legal advisor that understands their particular tax circumstances and the rules governing their state. In no way is this information intended to be tax or legal advice.