Tax deductions are designed to assist business owners in running a profitable business. It is worth exploring the many ways company life insurance can benefit your business, and the potential tax advantages that go along with it.
As a business owner, you cannot be an expert in every area of business. Other business experts such as tax accountants, attorneys, and consultants are good resources to rely on for information in the areas where you lack expertise. For instance, a savvy business owner works closely with a tax accountant to ensure they are leveraging every available tax opportunity. Moreover, a business attorney or consultant can help you understand the benefits life insurance provides for your business.
At the same time, it is wise to do some of your own research. To give you a leg up, we will shed some light on why life insurance is important for small business owners and how tax advantages fit into the equation.
Why Is Life Insurance Important for Business Owners?
Whether you are an entrepreneur or a seasoned business owner, it is important to have life insurance. Why? Because it protects everything and everyone you care about, including your business, business partners, employees, and your family.
Take a moment to think through a scenario where you perish in an auto accident. What would happen to your family and business partner? It is hard enough to lose someone you love or are close to, and financial stress only adds to the grief and heartache.
As a business owner, you have a mountain of tasks to do every day. Would your business partner be capable of taking over your duties? Would they need to hire someone to help if you did not show up for work the next morning? In these situations, key person life insurance is a way to support your business.
What about your spouse or partner? Would that person be able to financially support your family without the benefit of your income? Would some of your assets be tied up in the company for a while? There is a way to use life insurance to keep your business running and allow your family members access to the funds they need to keep the household humming.
Your presence will surely be missed at home and at work if you pass away unexpectedly. Yet, the business you worked so hard to build will still be important to your family and other people connected with your business. Your customers, vendors, and other business acquaintances you worked with in your course of business will become concerned about what will happen to your business in the event of your death. A life insurance policy ensures your business will continue operating, and will also allow your family to maintain their current lifestyle even after your death.
What about your business partner? The right life insurance policy will give your business partner the funds to buy out the business if they choose to do so.
Should you buy a personal life insurance policy, one for the business, or both? In most cases, it is best to buy both because each serves a different purpose. There are different types of business life insurance policies to consider.
How Business Owners Can Use Life Insurance for Business Purposes
The type of life insurance you should buy as a business owner depends on what your purpose is. Below is a description of several types of life insurance policies you may want to consider purchasing.
Corporate Ownership of Life Insurance (COLI)
A business can purchase a life insurance policy. The name of this type of policy is a Corporate Owned Life Insurance Policy, also known as COLI. With this type of policy, the company is the owner; furthermore, the beneficiary of the policy and the company itself pays the premiums. The insured could be anyone who has an insurable interest in the company, including an owner, debtor, or employees of the company.
A COLI may be used to fund a non-qualified deferment compensation plan. The primary advantage of this is the benefits are protected against cash flow fluctuations.
Business owners also have the flexibility of borrowing from the cash value in a COLI policy, which is essentially borrowing from yourself rather than from the bank.
Another option for business owners is to use COLI funds to pay employees severance in the event a decision is made to close the business.
Key Person Life Insurance
There are certain people in every company who are somewhat indispensable. For example, this could be one of the partners or a high-level executive. The idea is if this key person were to pass away, they would be difficult to replace, and the business would materially suffer.
A sole proprietor may also purchase key person life insurance so their family members receive funds to allow them to continue the business.
With key person insurance, the business and beneficiary own the policy. Additionally, the business would be responsible for paying the premiums. If the key person dies, the business will receive the funds which would allow the partner or the family members to continue running the business.
When there are two or more partners in a business, it is best to sign a buy-sell agreement. A buy-sell agreement is a contract that sets a pre-determined price for the surviving partner to buy the deceased person’s share of the business. Life insurance policies are usually used to fund the buy-sell agreement, so the surviving partner does not have to use their own funds to buy the business.
Life Insurance for Charitable Giving
Do you have a favorite charity that is near and dear to your heart? Perhaps you have thought about making a large donation to a particular charity upon your death.
There are two ways to do this by using life insurance. One is by adding a charitable giving rider to a life insurance policy, and the other is to name the charity as the beneficiary of your life insurance policy. With a charitable giving rider, a specified portion of the policy would automatically be given to the charity upon your death.
Individual Life Insurance
At a minimum, every business owner should have an individual term or permanent life insurance policy. It is very costly to run most businesses. If an owner passes away and there are no available assets, the family could use the payout from the life insurance policy to pay for utilities, mortgage, or lease payments, and possibly pay employees to keep the business running until a decision is made on how to handle the business permanently.
Group Term Life Insurance
Group term life insurance is a basic employee insurance policy covering multiple people. A business owner may opt to purchase a group term life insurance policy for all employees working for the company. The life insurance policy would then be offered to the employees as part of their benefits package.
In this case, the business and business owners do not directly benefit from the life insurance, but they can feel good about offering it to their employees in honor of the hard work they do for the company.
Are Life Insurance Premiums Tax-Deductible for Business Owners?
There is not really a simple answer on whether life insurance premiums are tax-deductible for business owners. Canada’s Income Tax Act spells out the rules for taxation on life insurance policies. The bad news is the rules are complex, and the index is lengthy. The good news is there are plenty of tax advantages for business owners who want to purchase life insurance.
With a COLI policy, the business pays for the premiums after taxes. This is a benefit because the tax rates are much lower than the personal shareholder tax rate. As another benefit, the insurance policy will be based on the cash surrender value before death, which is generally lower than what it would be after death.
The premiums on a key person life insurance policy are taxable because Canadian law does not allow tax deductions on life insurance policies where the business is the beneficiary.
As for a life insurance policy that is used for charitable giving, life insurance policy premiums are tax-deductible, as long as the charity is the owner of the policy. In a policy that has a charitable giving rider, no deductions are allowed because the business or business owners are the owners of the policy.
Individual life insurance policies in the name of a business are also not tax deductible, as the intention is for the policy proceeds to be non-taxable to maximize the payout upon death. Overall, it is best to get advice from a tax accountant on this issue.
Businesses that purchase group term life insurance for their employees may deduct their premiums at tax time, as long as they are considered a reasonable business expense.
Final Thoughts
Just as you want to protect your family at an unknown time like death, it is just as important to protect your business, business partners, employees, and customers. Company life insurance gives you the peace of mind in knowing your business and family will be able to continue on comfortably after your passing.
Every business is different and has various needs for life insurance for the business. Now that you have the 411 on life insurance as a business expense, the next best step you can take is to give an agent at Hometown Insurance a call to see how it can work for you. Call now at 289-606-0103.
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