273 / What are the tax consequences when an S corporation pays a premium on a life insurance policy insuring a shareholder or employee?
An S corporation generally does not pay taxes; instead, items of income, deduction, loss, and credit are passed through to shareholders who report their pro rata shares on their individual returns. Payment of premiums by an S corporation should be characterized as a nondeductible expense, as deductible compensation, or as a nondeductible distribution of profits under the same general rules applicable to regular (C) corporations ( Q 264 to Q 271).The resulting tax treatment of the shareholders would differ in some instances.
Where the payment is a nondeductible expense, as it would be if a corporation was both owner and beneficiary of a key person policy, each shareholder reduces his or her basis in his or her shares by his or her proportionate part of the nondeductible expense.1
If particular premium payments are considered compensation as in the example where an employee owns a policy or has a beneficial interest in it ( Q 269 to Q 271), the amount of compensation would be deductible in determining the corporation’s income or loss that is reported pro rata by each shareholder. The amount of compensation then would be included in income by the insured employee.2