262 / Are premiums paid on business life insurance deductible as business expenses?

Life insurance premiums generally are not deductible if the payer of the premium has any interest in the policy or proceeds.

IRC Section 264(a)(1) expressly provides that no deduction shall be allowed for premiums paid on any life insurance policy, or endowment or annuity contract, if a taxpayer is directly or indirectly a beneficiary under the policy or contract. Where Section 264(a)(1) applies, the premiums are not deductible even though they otherwise would be deductible as ordinary and necessary business expenses.¹ The rule under Section 264(a)(1) is an all or nothing rule. Even though the payer of a premium has a right to receive only a portion of the proceeds, the entire premium is nondeductible. The deduction cannot be divided but must either be allowed or disallowed in total.² The rule under Section 264(a)(1) applies regardless of the form of insurance, so it makes no difference whether premiums are paid on term, ordinary life, or endowment policies.

Deduction of a premium clearly is prohibited under Section 264(a)(1) where a taxpayer who is the payer of the premium is designated as the beneficiary in the policy. For example, premiums paid on key person insurance, where an employer normally is both owner and beneficiary of a policy, clearly are nondeductible by reason of IRC Section 264(a)(1). A deduction likewise is denied under Section 264(a)(1) where a premium payer is only indirectly a beneficiary under a policy. Thus, a deduction is denied where a taxpayer, even though not a named beneficiary, has some beneficial interest in a policy, such as the right to change the beneficiary, to make loans, to surrender the policy for cash, or to draw against proceeds held in trust for the insured’s spouse.³

An employer is permitted to deduct premiums paid on insurance covering the life of an employee, however, if the employer is not directly or indirectly a beneficiary under the policy and the premiums represent additional reasonable compensation for services rendered by an employee. Thus, if an employer has no ownership rights or beneficial interest in a policy and proceeds are payable to an employee’s estate or personal beneficiary, premiums ordinarily are deductible by the employer as additional compensation to the employee.⁴ The deduction will not be denied merely because an employer may derive some benefit indirectly from the increased efficiency of an employee.⁵