Is Life Insurance a Business Expense? Tax Rules for Business Owners

Business owners often ask whether life insurance premiums are a deductible business expense. The short answer is: sometimes. It depends on who owns the policy, who the beneficiary is, and how the coverage fits into employee compensation. Premiums on a policy that benefits the business itself are generally not deductible, while life insurance provided to employees as a benefit often is.

This guide explains the general federal tax rules for common business life insurance arrangements. It’s educational only. Tax rules are complex and change, so confirm your situation with a CPA or tax attorney before you buy.

The general rule: who benefits matters

Under federal tax law, a business generally can’t deduct premiums on a life insurance policy if the business is directly or indirectly a beneficiary. The reasoning is that the business would otherwise get a deduction for premiums and a tax-free death benefit. On the other hand, when life insurance is part of an employee’s compensation, the business can usually deduct the cost, much like wages or other benefits, as long as total compensation is reasonable.

Key person life insurance

Key person insurance protects a business against the financial loss of an owner or employee whose skills, relationships, or revenue are hard to replace. The business buys the policy, pays the premiums, and is the beneficiary. The money can help cover lost revenue, recruit a replacement, reassure lenders, or keep operations running.

Because the business is the beneficiary, premiums are generally not deductible. The death benefit is generally received tax-free, provided the business meets the notice-and-consent and reporting requirements for employer-owned life insurance described below.

Buy-sell agreements

A buy-sell agreement sets out what happens to an owner’s share of the business if they die. Life insurance is the most common way to fund it, so surviving owners or the business have cash to buy the deceased owner’s interest from their family.

• Entity purchase (redemption). The business owns policies on each owner and buys back the deceased owner’s share. Premiums are generally not deductible.
• Cross-purchase. Each owner owns a policy on the others and buys the deceased owner’s share personally. Premiums are paid by the owners personally and generally aren’t deductible.

Each structure has different tax consequences for the cost basis of the surviving owners and for estate planning, so the choice deserves careful advice.

Group-term life insurance for employees

Group-term life insurance that a business provides to employees is generally a deductible business expense. For employees, the first $50,000 of employer-paid coverage is generally tax-free. The cost of coverage above $50,000 is treated as taxable income to the employee, calculated using an IRS table and reported on the W-2, as explained in IRS Publication 15-B. Learn more about how these plans work in group life insurance.

Executive bonus (Section 162) plans

In an executive bonus plan, the business pays a bonus to a key employee, who uses it to pay premiums on a policy they own. The employee names their own beneficiaries and controls the policy. Because the bonus is compensation, the business can generally deduct it, as long as total compensation is reasonable. The employee pays income tax on the bonus. Some businesses “double bonus” to cover that tax. These plans are simple to set up and are often used to reward and retain key people, especially with permanent policies that build cash value.

Split-dollar arrangements

Split-dollar arrangements divide the costs and benefits of a policy between the business and an employee, often with the business recovering its premium outlay later. Tax treatment depends on how the arrangement is structured, such as an economic benefit or a loan regime, and the rules are technical. These plans usually require help from specialists.

What about sole proprietors and small business owners?

If you’re self-employed and buy life insurance on yourself to protect your family, the premiums are generally treated as a personal expense, not a business deduction, even if you pay them from a business account. The same is usually true for owners of S corporations and partnerships buying personal coverage. Different rules can apply to coverage provided to employees or structured through a formal plan, so ask your tax advisor.

Employer-owned life insurance rules

When a business owns a policy on an employee and is the beneficiary, federal tax rules generally require the business to notify the employee in writing and get their consent before the policy is issued. If those steps aren’t followed, part of the death benefit may become taxable. Businesses that own these policies must also file IRS Form 8925 each year. Working with an agent and advisor who handle business cases helps make sure these requirements are met.

Are death benefits taxable to a business?

Life insurance death benefits are generally received free of federal income tax, according to the IRS. For employer-owned policies, that tax-free treatment generally depends on meeting the notice-and-consent and reporting requirements. Large death benefits received by C corporations may also have alternative minimum tax considerations in some cases. Your tax advisor can review the details.

How much business life insurance do you need?

• Key person coverage: Often estimated as a multiple of the person’s salary, their contribution to profits, or the cost to recruit and train a replacement.
• Buy-sell coverage: Typically equal to each owner’s share of the business’s fair market value, updated as the business grows.
• Loan coverage: At least the outstanding balance of business loans that a lender requires to be insured.

Review business coverage regularly, since company values and loan balances change.

Term or permanent for business needs?

Term life insurance is often the most cost-effective choice for key person coverage and loan protection, since those needs usually last a set number of years. Permanent coverage can make sense for buy-sell agreements that need to last until an owner retires or dies, and for executive bonus plans designed to build cash value. See permanent life insurance and term life insurance.

Questions to ask your CPA or tax advisor

• Who should own the policy, and who should be the beneficiary?
• Will premiums be deductible under this structure?
• Will the employee owe tax on any part of the coverage?
• Have we met the notice-and-consent requirements for employer-owned coverage?
• How will this affect the business’s value, the owners’ cost basis, or estate planning?

Example: a two-owner business

Here’s a hypothetical example. Lena and Marco each own half of a landscaping company valued at $1.2 million. They sign a buy-sell agreement and fund it with life insurance so the survivor can buy out the other’s family. They also want key person coverage on Marco, who manages the company’s largest commercial accounts.

• Buy-sell coverage: Using a cross-purchase design, each owner buys a $600,000 policy on the other. They pay the premiums personally, and the premiums aren’t deductible. If Marco dies, Lena receives the death benefit and uses it to buy Marco’s share from his family.
• Key person coverage: The company buys a policy on Marco and names itself as beneficiary. Premiums aren’t deductible, but the death benefit can help replace lost revenue and hire a new manager, as long as the company completed the employer-owned policy notice-and-consent steps.
• Employee benefit: The company also provides $25,000 of group-term life coverage to each employee. Those premiums are generally a deductible business expense, and because each employee’s coverage is under $50,000, employees generally don’t owe tax on it.

The right structure for your business depends on the number of owners, your entity type, and your estate plans, which is why this is a decision to make with your tax advisor and an experienced agent.

Common mistakes to avoid

• Assuming all premiums are deductible because the business pays them.
• Skipping the employer-owned policy notice and consent, which can make part of the death benefit taxable.
• Letting buy-sell coverage fall behind the business’s value, leaving survivors without enough cash to complete a buyout.
• Naming the wrong owner or beneficiary, which can change both tax treatment and who controls the money.
• Forgetting personal coverage. Business policies protect the company. Your family may still need its own protection.

The bottom line

Life insurance can be a business expense when it’s provided to employees as compensation, such as group-term coverage or an executive bonus plan. When the business owns the policy and collects the benefit, as with key person or entity buy-sell coverage, premiums generally aren’t deductible, but the death benefit is usually tax-free if the rules are followed. Get the structure right from the start with help from a tax advisor and a licensed agent who works with business owners.

Business life insurance tax FAQs

Is life insurance a business expense?

It can be. Premiums for group-term coverage provided to employees, or paid as part of executive bonus compensation, are generally deductible. Premiums on policies where the business is the beneficiary, such as key person or entity buy-sell coverage, generally are not.

Can I deduct my own life insurance as a self-employed person?

Generally, no. Life insurance you buy on yourself to protect your family is usually a personal expense, even if paid from a business account.

Is key person life insurance tax deductible?

Generally, no, because the business is the beneficiary. The death benefit is usually received tax-free if employer-owned policy requirements are met.

Are life insurance proceeds taxable to a business?

Generally, death benefits are received tax-free, but employer-owned policies must meet notice-and-consent and reporting rules, and some corporations may face alternative minimum tax considerations.

What is a Section 162 executive bonus plan?

It’s an arrangement where a business pays a deductible bonus to an employee, who uses it to pay premiums on a policy they own. The employee pays income tax on the bonus.

This article is for general educational purposes and isn’t tax or legal advice. AccuQuote agents are licensed insurance professionals, not tax advisors. Consult a qualified CPA or attorney about your situation.