The death of an officer can be devastating for a business. Apart from the emotional difficulty, it can also derail the company on a financial level. Officer life insurance mitigates some of this risk by offering a cash payout in the event of an officer's death. Unfortunately, the premiums on this plan only are tax-deductible if the officer himself is the beneficiary.
Insurance Premiums and Taxes
Life insurance premiums are a tricky part of the tax code. Whether or not the premiums are deductible depends on the plan beneficiary. Officer and employee life insurance are deductible to the company if the officers and employees themselves are the beneficiaries. However, this doesn't provide any financial benefit for the company in the event of a death. If the company itself is a beneficiary under the contract, the premiums are not deductible. This type of life insurance is referred to as "Corporate-owned life insurance," or COLI for short.
There is some logic to the fact that COLI premiums are nondeductible. Proceeds from life insurance are treated as tax-free income to the beneficiary. If the insured individual dies, the company paying the premiums generally won't have to pay taxes on the insurance payout. Allowing a deduction for the payments and excluding the income for tax purposes would create a double tax benefit.
Withdrawals and Loan Proceeds
Businesses can choose to borrow against the cash value of a COLI plan or make a withdrawal. The interest expense on a COLI loan is tax deductible if the company pays at least four years of premiums before initiating the loan. If the business withdraws cash from the COLI plan, the withdrawal is tax free to the extent of premiums paid less dividends and other distributions. That's because the Internal Revenue Service considers the withdrawal a recovery of interest.
Financial Reporting vs. Tax Reporting
COLI premiums are deductible for financial reporting purposes, but not for tax purposes. That means that if your business follows generally accepted accounting principles, you should record the life insurance premiums as an expense. However, the IRS does not allow businesses to deduct the premiums for tax purposes. When it's time to file taxes, the business must add back those premiums to taxable income so they don't claim a deduction for them. This is referred to as a "permanent book-tax difference," because the company will never be able to deduct the expense.
- IRS.gov: Publication 535 -- Nondeductible Premiums
- Bay Colony Partners: What is Corporate-owned Life Insurance?
- Boyum & Barenscheer: Office Life Insurance
- Congressional Research Service. "Corporate-Owned Life Insurance (COLI): Insurance and Tax Issues," Pages 1-2. Accessed Sept. 17, 2020.
- Congressional Research Service. "Corporate-Owned Life Insurance (COLI): Insurance and Tax Issues," Page 3. Accessed Sept. 17, 2020.
- Internal Revenue Service. "Notice 2009-48," Pages 6-7. Accessed Sept. 17, 2020.
- Congressional Research Service. "Corporate-Owned Life Insurance (COLI): Insurance and Tax Issues," Pages 3-4. Accessed Sept. 17, 2020.
Based in San Diego, Calif., Madison Garcia is a writer specializing in business topics. Garcia received her Master of Science in accountancy from San Diego State University.