By Jeffrey C. Fleischner, JD
Vice President, Set for Life Insurance
A common question is whether the premium for an individual disability insurance policy is deductible as a business expense for Federal tax purposes. For self-employed tax payers, the answer is “yes,” but choosing to deduct the premium will have adverse income tax consequences on the benefits paid by the policy under a claim.
If you deduct the insurance premium as a business expense, then the benefit paid by the disability insurance policy during a claim is taxable income. In contrast, if you do not deduct the premiums as a business expense then the benefits are excluded from taxable income. See IRC sec. 104.
We believe that self-employed individuals should NOT deduct the premiums of an individual disability policy as a business expense.
The purpose of the disability benefit provided by your disability insurance is to provide you with sufficient income to cover your needs while disabled. In many circumstances, a person’s financial needs may actually increase while disabled (for example, by increased costs of medicine or treatment that is not fully covered by health insurance). The value of the insurance benefit is eroded when the disability benefit becomes taxable income. It is more advantageous to obtain the disability insurance benefits tax-free when disabled (and presumably when you may have little other significant income), than to take the business expense tax deduction.
We recommend that you discuss this issue with your tax advisor to determine what is best for your specific circumstances. If you decide to deduct the premiums as a business expense, then it may be necessary to purchase additional monthly disability benefits to pay the tax liability you will incur under a claim, or you will have less benefit available after taxes.