Is Life Insurance Tax Deductible for Business Owners?

Usually not. Federal tax law says no deduction is allowed for life insurance premiums if you, or your business, are directly or indirectly a beneficiary of the policy. That rule covers most of the policies owners buy: coverage on your own life for your family, key person insurance, and policies that fund a buy-sell agreement.

There are real exceptions. A business can generally deduct life insurance it provides to employees as part of their pay, such as group-term life coverage or an executive bonus arrangement. This guide walks through each case in plain terms. It is general information, not tax advice, so check your own situation with a CPA or enrolled agent.

Can a sole proprietor deduct life insurance premiums?

No, not for a policy on your own life. IRS Publication 334 says you can't deduct your own salary or personal withdrawals from your business, and that "as a sole proprietor, you are not an employee of the business."

A policy that pays your family if you die protects your household, not your business's income. Federal law, 26 U.S.C. § 262, says no deduction is allowed for "personal, living, or family expenses." The same answer generally applies to a single-member LLC that files on Schedule C, since the owner is still not an employee.

What a sole proprietor can deduct is life insurance for your employees, if you have any. Publication 334 lists "life insurance covering your employees if you are not directly or indirectly the beneficiary under the contract" among deductible business insurance.

If you are still working out how much personal coverage you need, start with our guide to life insurance for self-employed people.

Why aren't key person and buy-sell premiums deductible?

Because the business, or a co-owner, is the beneficiary. IRC § 264(a)(1) says no deduction is allowed for "premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the policy."

The Treasury regulation behind it, 26 CFR § 1.264-1, goes further. If a business takes out a policy "for the purpose of protecting himself from loss in the event of the death of the insured," it is treated as a beneficiary. That describes key person life insurance almost word for word.

Buy-sell policies work the same way. Whether the company owns the policies or the co-owners own policies on each other, the party paying the premium usually collects the death benefit, so there is no deduction. Our guide to buy-sell agreement life insurance covers how those plans are set up.

The trade-off is that the death benefit itself is generally not taxable income under IRC § 101(a). For a policy a business owns on an employee, § 101(j) adds a condition. Before the policy is issued, the employee must get written notice of the plan and the maximum face amount, and must give written consent, and one of the law's exceptions must apply. Otherwise most of the payout can become taxable.

When can a business deduct life insurance premiums?

When the premium is really part of an employee's pay and the business is not the beneficiary. The table below sums up the common setups.

Group-term life insurance (Section 79)

Group-term life is a common deductible setup. IRS Publication 15-B says employers can generally exclude the cost of up to $50,000 of group-term coverage from an employee's wages. Coverage above $50,000 is taxable to the employee and shows up on the W-2 in box 12 with code C. That matches 26 U.S.C. § 79.

To count as group-term life insurance, the plan has to meet IRS conditions. The coverage must go to a group of employees, and the amount must be set by a formula, such as a multiple of pay, rather than picked person by person. Publication 15-B also says the plan generally must cover at least 10 full-time employees at some point in the year, though two exceptions can apply to smaller employers.

Owners are the catch. For this exclusion, Publication 15-B treats as employees mainly current and former common-law employees. It also says not to treat a more-than-2% S corporation shareholder as an employee for this exclusion, so the $50,000 break doesn't cover them. In plain terms, unless you work as an employee of your own C corporation, the $50,000 tax break is built for your staff, not for you.

Executive bonus plans (Section 162)

An executive bonus plan, sometimes called a Section 162 plan, is simpler than it sounds. The employee owns an individual policy and names their own beneficiary, and the business pays the premium as extra pay.

The business deduction rests on IRC § 162(a)(1), which allows "a reasonable allowance for salaries or other compensation for personal services actually rendered." Publication 334 lists bonuses as a kind of pay and adds that pay must be reasonable and for services performed.

The employee pays tax on it. Under 26 CFR § 1.61-2, premiums an employer pays on an employee's life, when the proceeds go to the employee's beneficiary, are part of the employee's gross income. Some plans add a second bonus to cover that tax.

For example, a hypothetical owner of a C corporation who also works as its president could have the company pay a $3,000 yearly premium on a policy she owns. If the pay is reasonable, the company may deduct the $3,000 and she reports it as income. The death benefit would go to her family, not the company.

Can you deduct life insurance an SBA or bank lender requires?

No. IRS Publication 334 addresses this directly: if you take out a policy on your life, or on the life of someone with a financial interest in your business, "to get or protect a business loan," you can't deduct the premiums as a business expense. You also can't deduct them as interest or as a cost of financing the loan.

The same passage says that if you die, the policy proceeds are not taxed as income even if they are used to pay off the debt. See our guide to the SBA loan life insurance requirement for when lenders ask for this coverage.

How are S corporation and partnership owners treated?

Mostly like sole proprietors when it comes to their own coverage. Publication 15-B says to treat a more-than-2% S corporation shareholder "as you would a partner in a partnership for fringe benefit purposes." Its fringe-benefit table adds that the Social Security and Medicare exemption for group-term coverage doesn't apply to these shareholders.

Partners aren't on Publication 15-B's list of people treated as employees for the group-term exclusion, so the $50,000 exclusion doesn't cover them. How a partnership reports premiums it pays for a partner depends on the facts. That's a question for your tax preparer.

C corporation owners who work in the business are usually employees of the corporation. That's why group-term life and executive bonus plans can work for them. Section 264 still applies whenever the corporation is a beneficiary.

What should you ask your tax professional?

Bring these questions to your CPA or enrolled agent before you buy:

1. Who will own the policy, who will pay the premium, and who will be the beneficiary?
2. Is the business "directly or indirectly" a beneficiary under IRC § 264?
3. If the business owns the policy, have we completed the § 101(j) notice and consent before it is issued?
4. If this is group coverage, do we meet the 10-employee rule or one of its exceptions?
5. If this is an executive bonus, is the total pay reasonable, and how will it show on the W-2?
6. If a lender requires the policy, how should we record the premium?

To size coverage first, try our life insurance calculator. For how death benefits and cash value are taxed in general, see is life insurance taxable. Or browse more guides in our self-employed life insurance hub.