What expense category is Life Insurance Expenses?

Life insurance is a versatile financial tool that businesses use for several strategic purposes, from providing valuable employee benefits to ensuring business continuity with key person insurance. For accountants and SMB owners, it's crucial to understand that the accounting and tax treatment of life insurance premiums is highly specific and depends entirely on the purpose of the policy and, most importantly, who the beneficiary is.

Unlike many other types of insurance, life insurance premiums are often not a deductible business expense. This guide will explain how to categorize life insurance costs, the critical considerations for classification, common examples, the tax implications, and how Fyle can help you track these payments accurately.

Life Insurance Expense Category

The correct accounting category for life insurance premiums hinges on whether the business can deduct the cost. This is determined by who benefits from the policy.

Deductible Expense: Employee Benefits 

If the life insurance policy is a benefit provided to employees, and the company is not the beneficiary, the premiums are considered a form of employee compensation. In this case, the cost is a deductible business expense and should be categorized as Employee Benefit Programs or Insurance. A common example is group-term life insurance.

Not an Expense: Asset or Equity Transaction 

If the business pays the premiums on a life insurance policy and is also the direct or indirect beneficiary, the premiums are not a deductible business expense. This includes key person insurance or policies used to secure a loan. From an accounting perspective, these premium payments are not expensed on the income statement. For permanent life insurance policies that build cash value, the portion of the premium that contributes to the cash value is treated as an asset on the balance sheet.

Important Considerations While Classifying Life Insurance Expenses

The Beneficiary Rule is Key

This is the most important factor in determining deductibility. As stated in IRS Publication 334 and Publication 535, you cannot deduct the cost of life insurance coverage for yourself, an employee, or any person with a financial interest in your business if your business is directly or indirectly the beneficiary of the policy.

Purpose of the Insurance

The reason for purchasing the policy dictates its treatment.

• Key Person Insurance: This protects the business from financial loss if a key executive or owner dies. The business is the beneficiary, so the premiums are not deductible.
• Insurance to Secure a Loan: If you take out a life insurance policy on an owner or employee to be used as collateral for a business loan, the premiums are not deductible as a business expense or as interest.
• Group-Term Life Insurance: This is a common employee benefit. Because the employees and their families are the beneficiaries, the premiums are generally a deductible expense for the business.

Policy Ownership

Who owns the policy is a critical factor. If the company owns the policy and is the beneficiary, the premiums are not deductible.

Examples of Life Insurance Expenses

Deductible Example

Your company pays the premiums for a group-term life insurance policy that provides a $50,000 benefit to the designated heirs of each of your 10 employees. These premiums are a deductible expense under "Employee Benefit Programs."

Non-Deductible Examples

You are the owner of an SMB, and the business takes out a $2 million life insurance policy on you to ensure the business can continue operations if you pass away. The business is the beneficiary. The premiums are not deductible.

Your company needs a significant bank loan. The bank requires you to take out a life insurance policy on your CEO as collateral for the loan. The premiums paid by the business are not deductible.

Two partners in a business purchase life insurance policies on each other to fund a buy-sell agreement, allowing the surviving partner to buy out the deceased partner's share. The premiums are not deductible business expenses.

Tax Implications of Life Insurance Expenses

The tax treatment of life insurance premiums is a critical area for compliance.

Deductibility

The IRS is very clear that premiums are only deductible when they are a form of employee compensation (like group-term life insurance) and the business is not the beneficiary.

Non-Deductibility

For any policy where the business is a beneficiary (key person, loan collateral), the premiums are not deductible from business income. Do not report these payments as an expense on your business tax return.

Tax-Free Death Benefit

While the premiums for company-owned life insurance (like key person policies) are not deductible, the death benefit the company receives is generally not considered taxable income. This is a key trade-off and part of the financial strategy behind these policies.

Reporting

Deductible life insurance premiums for employees are reported on the appropriate line of your business tax return, such as "Employee benefit programs" on Form 1120 for corporations or Schedule C for sole proprietors.

Life Insurance Expense Tracking with Fyle

While Fyle does not provide tax advice, it is an essential tool for maintaining the clear records required to correctly classify and substantiate your insurance payments.

• Track All Premium Payments: Fyle can track recurring premium payments made via company credit card or bank transfer, ensuring no payment is missed.
• Centralize Crucial Documents: For each insurance policy, you can upload and attach the policy document, beneficiary designation forms, and premium invoices directly to the expense transactions in Fyle. This is critical for proving the nature of the policy and justifying its tax treatment during an audit.
• Correct Categorization: Create distinct categories in Fyle to prevent errors. For example, you can have separate categories for "Employee Benefits - Group Life (Deductible)" and "Key Person Insurance (Non-Deductible)."
• Seamless Accounting Integration: Fyle’s direct integrations with accounting software like QuickBooks, Xero, NetSuite, and Sage Intacct ensure that these categorized transactions are synced correctly. A deductible premium can be posted to an "Employee Benefits" expense account, while a non-deductible premium payment can be correctly posted to a balance sheet account like "Cash Value of Life Insurance."

By using Fyle to meticulously document and categorize every life insurance payment, you create a transparent, audit-ready record that helps ensure your business stays compliant with complex IRS regulations.