What expense category is Credit Insurance Premiums?

Extending credit to customers is a common business practice, but it also carries the risk that some invoices may go unpaid. A business's bad debt can impact cash flow and profitability. To mitigate this risk, many businesses purchase credit insurance, which protects against losses from customer non-payment.

For accountants and small business owners, it's important to know that the premiums paid for this type of insurance are a deductible business expense. This guide explains how to categorize credit insurance premiums in accordance with IRS rules and provides guidance on tracking them effectively.

Credit Insurance Premiums Expense Category

The premiums you pay for credit insurance are an ordinary and necessary business expense. IRS Publication 535 specifically lists Credit insurance that covers losses from business bad debts as a deductible type of insurance.

On your financial statements, these premiums should be categorized under Insurance Expenses. This ensures they are tracked separately from other types of insurance and bad debt losses themselves.

Important Considerations When Classifying Credit Insurance

While the premiums are deductible, there are several key IRS rules to understand, particularly concerning how this insurance interacts with bad debt deductions.

Deductible Insurance vs. Non-Deductible Self-Insurance

The deduction for insurance premiums applies only to payments made to a third-party insurance company or a government agency. As stated in IRS Publication 535, you cannot deduct amounts you set aside in your own self-insurance reserve fund to cover potential bad debts.

The Bad Debt Deduction and Insurance Recoveries

You cannot deduct the same loss twice. If you have credit insurance, it directly impacts your ability to deduct a bad debt.

• If an insured customer account becomes uncollectible, you must first file a claim with your insurance provider.
• Any amount you recover from the insurance policy reduces the amount of your loss.
• You can only take a bad debt deduction for the portion of the debt that is not covered by insurance.

For example, if you have a $10,000 bad debt and your credit insurance policy reimburses you for $8,000, you can only claim a bad debt deduction for the remaining $2,000 loss.

The Prepayment Rule

Like other insurance policies, if you pay for a credit insurance policy that covers a period extending substantially beyond the end of the tax year, you cannot deduct the entire premium upfront. 

According to IRS Publication 535, you must allocate the premium and deduct only the portion that applies to the current tax year.

Examples of Credit Insurance Use

• A manufacturing company sells goods on credit to a large retailer. The manufacturer pays an annual premium for a credit insurance policy. If the retailer declares bankruptcy and fails to pay its invoices, the insurance policy covers a percentage of the loss. The premium for this policy is a deductible insurance expense.
• A consulting firm has a policy to cover its accounts receivable. A client disputes a bill and refuses to pay. The firm files a claim and recovers 75% of the invoice amount from its credit insurer. The firm can deduct the insurance premium it paid, plus the unrecovered 25% of the invoice as a bad debt (provided it uses the accrual accounting method).

Tax Implications and Recordkeeping

To properly deduct credit insurance premiums, you must report them correctly and maintain the records required by the IRS.

How to Report the Deduction

For a sole proprietor filing a Schedule C (Form 1040), credit insurance premiums are deducted under Part II, Line 15, Insurance (other than health).

What Records to Keep

You must keep documentary evidence to support your deduction. Your records should include:

• The credit insurance policy documents.
• Invoices from the insurance provider for the premiums.
• Proof of payment, such as canceled checks or credit card statements showing the premium payments.
• Any documentation related to claims filed and reimbursements received is critical for calculating any separate bad debt deductions.

How Fyle Can Automate Tracking of Insurance Premiums

Fyle simplifies the process of tracking insurance premiums and related documentation, ensuring you have a complete and compliant record for tax time.

• Centralized Policy Documents: Forward your credit insurance policy and any invoices directly to Fyle to create a centralized, easily accessible digital record.
• Track Premium Payments: Capture premium payments made via corporate card in real-time, or submit invoices for other payment methods, ensuring every cost is accurately recorded.
• Automate Your Accounting: Fyle syncs the expense directly to your Insurance Expense account in QuickBooks, Xero, NetSuite, or Sage Intacct, eliminating manual data entry.