Is Key Man Insurance Deductible?
Is Key Man Insurance Deductible as a Business Expense?
Key man or key person life insurance provides a lump sum of cash (death benefit) to a company upon the death of an employee or business owner. The money can be used to help find a replacement, pay expenses, or even buy out ownership shares – essentially buying time for the business to keep running and to facilitate moving forward.
Who Owns the Key Man Insurance Policy and Who Benefits?
Business owners are often surprised to learn that although the business will buy life insurance, own the policy, and pay the premiums, the cost of the policy usually cannot be deducted as a business expense.
To claim key person premiums as a business expense, a company would need to include those life insurance costs in the employee’s reported taxable income. The employee’s own beneficiaries would probably be named instead of the business, and so this situation is more like an employment benefit rather than key person insurance.
Tax Treatment of Key Man Insurance
Tax treatment for business owners
After the key employee passes, any death benefit paid to the company is typically not subject to tax. However, tax treatment of the death benefit varies depending on the form of the company. For example, C corporations must include proceeds as subject to alternative minimum tax.
It’s also important to note the tax consequences of disposing of key person insurance. For example, if the key person retires and the company no longer needs the policy, the company could consider selling it in a transaction known as a life settlement. A life settlement will have tax consequences depending on the amount received – which depends upon the insured’s ages and health and life expectancy — and the amount of premiums paid into the policy.
Tax treatment for employees
Alternatively, the company could transfer ownership of the policy to the retiring employee as a perk or retirement gift. The transfer to personal life insurance would be considered compensation, and any value would be subject to the employee’s income taxes.
Contact Monarch Insurance
Key person insurance – whether it is cash value or term life insurance — can be a critical part of your business continuity plan. Contact Monarch Insurance Partners for help purchasing life insurance, choosing insurance companies, providing life insurance quotes, and determining appropriate term lengths. We are happy to work with your tax professional to make sure any plans are set up properly for the large or small business you’ve worked so hard to build.