Many businesses have learned the importance of having a key man insurance policy for their owners and other key personnel. You are probably wondering if you can include the policy on your tax deductibles list for business owners.
Do not assume this is a business expense. You must be aware of how the IRS views this type of policy. You must comply with all requirements of the Pension Protection Act of 2006.
If you own or are planning to purchase a key man insurance policy, read on to learn its impact on your business taxes.
Key Man Insurance Legal Obligation
This type of life insurance is different than any other policy. The business is both owner and beneficiary of the policy. The employee does not have rights of ownership, but the company must advise the employee of their intent to purchase insurance.
This includes notification of all details of the policy. The business must also receive the employee’s written permission to purchase.
Your businesses must also file Form 8925 Report of Employer Owned Life Insurance Contracts with your yearly taxes. This provides the IRS with information on how many key person insurance policies your company has at the end of each year.
Insurable Interest
For a business to purchase a key man insurance policy the business must demonstrate an insurable interest in that employee’s life. To meet these qualifications the employee:
- Has special skills the business is highly dependent on
- Generates a substantial portion of revenue for the business
- Business reputation is linked to the individual’s name
- Business partners wish to buy out the ownership portion of a partner who dies
- The business has debt that will be difficult to pay if the key individual is disabled or dies
- Business is seeking either investors or a loan that requires key person insurance on the firm’s main leaders
If the person who the business wishes to purchase insurance on meets at least one of the above qualifications, they will be able to obtain a policy.
Key Man Insurance Policy Tax Help for Business Owners
For many years both the IRS and the federal government have been encouraging businesses and individuals to buy life insurance for financial security. The main inducement is that death benefits are payable to the beneficiary tax-free. Because the payout is tax-free, premiums are not tax-deductible.
The directive on this is IRS Section 264(a)(1) which states that business deductions are not allowed on any endowments, life insurance, or annuity policies if the taxpayer is a beneficiary of the contract.
The IRS addresses this in the Pension Protection Act of 2006, which applies to all employer-owned life insurance purchases made after August 17, 2006. The code prevents corporations from purchasing key man insurance on employees who are not key persons.
This directive is found under IRC Section 101(j)(1) and specifies that death benefits on employer-owned life insurance are taxable if it is in excess of the premiums paid. This does not apply if the policy meets one of the exemptions in IRC 101(j)(2). If the business purchased the policy prior to August 17, 2006, it is grandfathered in and is not subject to these rules.
The Answer to Is Key Man Insurance Tax Deductible?
Purchasing a key man insurance policy is a benefit to the company, but because they will obtain a tax-free payout in the event the employee dies or is disabled, the premiums paid are not tax-deductible. This insurance does provide peace of mind that the business will be able to continue operations in the event of the unforeseen incident of one of its key persons.
We at Hummel Group are committed to providing our clients with insurance that best fits their business needs. Contact us for a free quote on any business insurance needs you have.