Business Tax Preparation · Business expenses, deductions and credits

Insurance expense

Most business insurance is deductible without difficulty, and the topic exists because of the exceptions. Two of them are traps that cost money: a policy on a life in which the business has an interest, and a premium paid far enough in advance to create an asset.

The rule

The deduction. insurance premiums against fire, storm, theft, accident or other similar losses in the case of a business are among the ordinary and necessary expenditures directly connected with the trade or business^TY2026 (Reg. § 1.162-1(a)). Two qualifications sit in the same sentence: no such item is included in business expenses to the extent it is used in computing the cost of property included in inventory or in determining the gain or loss basis of plant, equipment or other property^TY2026, and — going the other way — the full amount of the allowable deduction for ordinary and necessary expenses in carrying on a business is deductible even though those expenses exceed the gross income derived from the business during the year^TY2026.

Life insurance where the business benefits. no deduction is allowed for premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the policy or contract^TY2026 (IRC § 264(a)(1)), and no deduction is allowed for interest on debt incurred or continued to purchase or carry a single premium life insurance, endowment or annuity contract, nor, subject to exceptions, on debt under a plan contemplating systematic borrowing of the increases in cash value, nor generally on debt with respect to a life insurance policy the taxpayer owns on any individual^TY2026 (IRC § 264(a)(2), (a)(3), (a)(4)).

Employer-owned life insurance. for an employer-owned life insurance contract, the amount the applicable policyholder may exclude from gross income on the death benefit is capped at the sum of the premiums and other amounts it paid for the contract^TY2026 (IRC § 101(j)(1)), unless the cap does not apply where the notice and consent requirements are met and the insured was an employee within the 12 months before death, or was a director or highly compensated employee when the contract was issued^TY2026 (IRC § 101(j)(2)(A)) — and in every case every applicable policyholder owning an employer-owned life insurance contract must file an annual return showing the number of employees, the number insured, the total insurance in force, and its own identifying details^TY2026 (IRC § 6039I(a)).

Prepaid premiums. a taxpayer need not capitalise an amount paid to create a right or benefit that does not extend beyond the earlier of 12 months after the first date the benefit is realised, or the end of the taxable year following the year of payment^TY2026 (Reg. § 1.263(a)-4(f)(1)).

Employee coverage. Premiums for employees’ accident and health coverage are deductible by the employer and excluded by the employee under IRC § 106(a) — except where the employee is treated as a partner, for which see for purposes of the fringe benefit provisions of subtitle A the S corporation is treated as a partnership and any 2-percent shareholder is treated as a partner of that partnership^TY2026 (IRC § 1372(a)).

Current figures

How it works in practice

The general rule is generous and the regulation says so twice over. insurance premiums against fire, storm, theft, accident or other similar losses in the case of a business are among the ordinary and necessary expenditures directly connected with the trade or business^TY2026 (Reg. § 1.162-1(a)) names insurance premiums expressly, and the full amount of the allowable deduction for ordinary and necessary expenses in carrying on a business is deductible even though those expenses exceed the gross income derived from the business during the year^TY2026 disposes of any argument that a deduction is limited to the income of the business. Property, casualty, liability, malpractice, business interruption, workers’ compensation and employer’s liability premiums are all ordinary and necessary in the ordinary case.

But not twice. no such item is included in business expenses to the extent it is used in computing the cost of property included in inventory or in determining the gain or loss basis of plant, equipment or other property^TY2026 (Reg. § 1.162-1(a)). A premium that has already been capitalised into inventory under IRC § 263A, or into the basis of a building under the uniform capitalization rules during construction, is not deducted again as an expense. This is the same principle that keeps selling expenses out of cost of goods sold, running in reverse.

Life insurance is where the deduction stops. no deduction is allowed for premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the policy or contract^TY2026 (IRC § 264(a)(1)). The test is whether the taxpayer is “directly or indirectly a beneficiary,” which reaches the ordinary key-person policy, the policy funding a corporate redemption under a buy-sell agreement, and the policy the business assigns to a lender as collateral. The premium is not deductible in any of them.

And the disallowance is symmetrical. The reason IRC § 264(a)(1) denies the deduction is that IRC § 101(a)(1) excludes the death benefit. A business paying non-deductible premiums receives tax-free proceeds; a business deducting premiums would receive taxable proceeds. Questions in this area become easy once the pairing is seen, because the answer to “is the premium deductible?” and the answer to “are the proceeds taxable?” always point in opposite directions.

Borrowing against a policy is separately disallowed. no deduction is allowed for interest on debt incurred or continued to purchase or carry a single premium life insurance, endowment or annuity contract, nor, subject to exceptions, on debt under a plan contemplating systematic borrowing of the increases in cash value, nor generally on debt with respect to a life insurance policy the taxpayer owns on any individual^TY2026 (IRC § 264(a)(2), (a)(3), (a)(4)). These are interest disallowances rather than premium disallowances, and they are directed at a specific arrangement — funding the premiums out of the policy’s own cash value — that would otherwise convert a non-deductible premium into a deductible interest cost.

Employer-owned life insurance carries a separate regime on the proceeds side. for an employer-owned life insurance contract, the amount the applicable policyholder may exclude from gross income on the death benefit is capped at the sum of the premiums and other amounts it paid for the contract^TY2026 (IRC § 101(j)(1)). Without more, the employer’s exclusion is limited to what it paid in, so the gain element of the death benefit is taxable. the cap does not apply where the notice and consent requirements are met and the insured was an employee within the 12 months before death, or was a director or highly compensated employee when the contract was issued^TY2026 (IRC § 101(j)(2)(A)) restores the full exclusion, but only where the notice and consent requirements of IRC § 101(j)(4) were met before the contract was issued — which cannot be cured afterwards. And every applicable policyholder owning an employer-owned life insurance contract must file an annual return showing the number of employees, the number insured, the total insurance in force, and its own identifying details^TY2026 (IRC § 6039I(a)) is an annual duty that runs for as long as the contract is held.

A prepaid premium meets the twelve-month rule. a taxpayer need not capitalise an amount paid to create a right or benefit that does not extend beyond the earlier of 12 months after the first date the benefit is realised, or the end of the taxable year following the year of payment^TY2026 (Reg. § 1.263(a)-4(f)(1)). A premium paid in November for the twelve months to the following October is deductible when paid by a cash method taxpayer; a three-year policy paid up front is not, and must be spread. The rule has two limbs and the benefit must clear both — twelve months from first realisation, and the end of the following taxable year.

How this has changed

None of the provisions on this page was amended by Pub. L. 119-21, so the 2026 rules are the 2025 rules. Two pieces of history explain why material on this topic is inconsistent.

IRC § 101(j) and IRC § 6039I were both added in 2006 by the Pension Protection Act, and they apply only to contracts issued after 17 August 2006. A business holding an older key-person policy is outside both, so its death benefit is fully excluded under IRC § 101(a)(1) with no notice and consent condition and no annual return. Two identical-looking policies can therefore have different answers depending only on when they were issued, and material written before 2006 is not wrong about the older contracts — it is simply silent about the newer ones.

The twelve-month rule is younger than most practitioners’ training. Reg. § 1.263(a)-4 was finalised in 2004, replacing a body of case law under which the treatment of a prepayment turned on a “one-year rule” that courts stated in several inconsistent forms. The regulation’s version is precise and has two limbs, and it is the two-limb structure that practitioners most often get wrong, because the older formulation asked only about the length of the benefit and not about the taxable year in which it ends.

The live point to watch is not in these provisions but next to them: because the employee’s exclusion for accident and health coverage under IRC § 106(a) does not reach a partner or a more-than-2-percent S corporation shareholder, the treatment of an owner’s premium depends on the entity’s classification. That is a question the business answers when it is formed, and a reclassification years later changes the answer for premiums the business has been paying all along.

Exam focus

Start by asking whose life is insured and who benefits. If the business is a beneficiary, the premium is not deductible and the proceeds are, in principle, excluded — and the question is usually testing whether you know both halves.

For an employer-owned contract issued after 2006, know that the exclusion is capped at premiums paid unless notice and consent were obtained before issue, and that the reporting duty is annual.

For a prepayment, apply both limbs of the twelve-month rule and check the year in which the benefit ends, not only its length.

Otherwise the general rule is generous: ordinary business insurance is deductible, it is deductible in a loss year, and the only thing that reduces it is prior capitalisation into inventory or basis.

Check yourself

1. A corporation pays $9,000 a year on a policy insuring its sales director, with the corporation as beneficiary. Is the premium deductible?

Answer: No. no deduction is allowed for premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the policy or contract^TY2026 (IRC § 264(a)(1)) — the corporation is directly a beneficiary under the policy. The counterpart is that the death benefit is excluded under IRC § 101(a)(1), subject to IRC § 101(j) for a contract issued after 2006.

2. The same corporation obtained no written consent from the director before the contract was issued in 2019. It receives $1,500,000 on his death, having paid $63,000 in premiums. What does it include in income?

Answer: $1,437,000. for an employer-owned life insurance contract, the amount the applicable policyholder may exclude from gross income on the death benefit is capped at the sum of the premiums and other amounts it paid for the contract^TY2026 (IRC § 101(j)(1)) caps the exclusion at the premiums and other amounts paid, and the cap does not apply where the notice and consent requirements are met and the insured was an employee within the 12 months before death, or was a director or highly compensated employee when the contract was issued^TY2026 is unavailable because the notice and consent requirements were not met before issue. The failure cannot be cured after the event.

3. A cash method business pays a $30,000 premium on 1 December 2026 for cover running to 30 November 2027. When is it deductible?

Answer: In full in 2026. a taxpayer need not capitalise an amount paid to create a right or benefit that does not extend beyond the earlier of 12 months after the first date the benefit is realised, or the end of the taxable year following the year of payment^TY2026 (Reg. § 1.263(a)-4(f)(1)) — the benefit does not extend beyond twelve months from first realisation, and it ends before the close of 2027, the taxable year following payment. Both limbs are satisfied.

4. A business has a loss for the year. Does that limit its deduction for liability insurance premiums?

Answer: No. the full amount of the allowable deduction for ordinary and necessary expenses in carrying on a business is deductible even though those expenses exceed the gross income derived from the business during the year^TY2026 (Reg. § 1.162-1(a)) — the full amount of the allowable deduction is available even though the expenses exceed the gross income derived from the business during the year. The limitations that turn on business income sit in IRC § 179(b)(3) and on the individual side, not in IRC § 162.

5. Why is a premium capitalised into the basis of a building under construction not also deducted?

Answer: no such item is included in business expenses to the extent it is used in computing the cost of property included in inventory or in determining the gain or loss basis of plant, equipment or other property^TY2026 (Reg. § 1.162-1(a)) — no item is included in business expenses to the extent it is used in computing the cost of property included in inventory or in determining the basis of plant, equipment or other property. The cost is recovered through depreciation instead.