IRS Materials: Insurance

Pub 334

Insurance

You can generally deduct premiums you pay for the following kinds of insurance related to your trade or business.

  1. Fire, theft, flood, or similar insurance.
  2. Merchandise and inventory insurance.
  3. Car and other vehicle insurance for vehicles used in your business if you do not use the standard mileage rate to figure your car expenses.
  4. Credit insurance on losses from unpaid debts.
  5. Liability insurance.
  6. Use and occupancy and business interruption insurance. This insurance pays you for lost profits if your business is shut down due to a fire or other cause. Report the proceeds as ordinary income.
  7. Overhead insurance. This insurance pays you for business overhead expenses you have during long periods of disability caused by your injury or sickness.
  8. Workers' compensation insurance set by state law that covers any claims for bodily injuries or job-related diseases suffered by employees in your business, regardless of fault.
  9. Contributions to a state unemployment insurance fund. You can deduct these contributions as taxes if they are considered taxes under state law.

You cannot deduct the following kinds of insurance premiums.

  1. Life insurance premiums. You generally cannot deduct the cost of life insurance paid on your own life. (See chapter 10 in Publication 535 for information on when life insurance premiums are deductible.)
  2. Self-insurance reserve funds. You cannot deduct amounts credited to a reserve you set up for self-insurance. This applies even if you cannot get business insurance coverage for certain business risks. However, your actual losses may be deductible.
  3. Loss of earnings. You cannot deduct premiums for a policy that pays for your lost earnings due to sickness or disability.

Self-employed health insurance deduction. You may be able to deduct 40% of the amount you paid for medical insurance for yourself and your family. You deduct this amount on line 27 of Form 1040.

Pub 535

Deductible Premiums

You can generally deduct premiums you pay for the following kinds of insurance related to your trade or business.

  1. Fire, theft, flood, or similar insurance.
  2. Credit insurance on losses from unpaid debts.
  3. Group hospitalization and medical insurance for employees including long-term care insurance.
    1. For partnerships, accident and health insurance for its partners as guaranteed payments made to the partners.
    2. For S corporations, accident and health insurance for its 2% shareholder-employees.
  1. Liability insurance.
  2. Malpractice insurance that covers your professional personal liability for negligence resulting in injury or damage to patients or clients.
  3. Workers' compensation insurance set by state law that covers any claims for bodily injuries or job-related diseases suffered by employees in your business, regardless of fault.
    1. If a partnership pays workers' compensation premiums for its partners, it can deduct these amounts as guaranteed payments to the partners.
    2. If an S corporation pays the workers' compensation premiums for its shareholders, it can deduct these amounts.
  1. Contributions to a state unemployment insurance fund. You can deduct these contributions as taxes if they are considered taxes under state law.
  2. Overhead insurance. This insurance pays you for business overhead expenses you have during long periods of disability caused by your injury or sickness.
  3. Car and other vehicle insurance. This insurance covers vehicles used in your business for liability, damages, and other losses. If you operate a vehicle partly for personal use, you can deduct only the part of your insurance premiums that applies to the business use of the vehicle. If you use the standard mileage rate to figure your car expenses, you cannot deduct any car insurance premiums.
  4. Life insurance covering your officers and employees if you are not directly or indirectly the beneficiary under the contract.
  5. Use and occupancy and business interruption insurance. This insurance pays you for lost profits if your business is shut down due to a fire or other cause.

Self-Employed Health Insurance Deduction

You can deduct 40% of the amount paid during 1997 for medical insurance and qualified long-term care insurance premiums for yourself and your family, if you are:

  1. Self-employed.
  2. A general partner (or a limited partner receiving guaranteed payments) in a partnership, or
  3. A shareholder owning more than 2% of the outstanding stock of an S corporation.

You are allowed this deduction whether you paid the premiums yourself or your partnership or S corporation paid them and you included the premium amounts in your gross income. Take this deduction on line 27 of Form 1040.

Percentage increases after 1997. For tax years beginning after 1997, the deductible percentage of your self-employed health insurance premiums gradually increases. The increases for later tax years are shown in the following table.

For Tax Yrs Beginning in: Deductible Percentage

1998 and 1999 45

2000 and 2001 50

2002 60

2003 -- 2005 80

2006 90

After 2006 100

Long-term care insurance deduction. Beginning January 1, 1997, qualified long-term care insurance contracts are generally treated as accident and health insurance contracts. You can deduct the premiums you pay for your employees as an employee benefit. Include these amounts in your employees' gross income. (The employees may be able to deduct the premiums as a medical expense.)

If you are self-employed and pay long-term care insurance premiums when figuring your self-employed health insurance deduction, include the lesser of:

  1. The amount you pay, or
  2. The amount shown below.

Use your age at the end of the tax year.

Long-term care insurance contract. A long-term care insurance contract is any insurance contract that only provides coverage of qualified long-term care services. The contract must:

  1. Be guaranteed renewable.
  2. Provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract may, be used only to reduce future premiums or increase future benefits.
  3. Not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed.
  4. Generally, not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer or the contract makes per diem or other periodic payments without regard to expenses.

Qualified long-term care services are:

  1. Necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and
  2. Maintenance or personal care services

that are required by a chronically ill individual and prescribed by a licensed health care practitioner.

Chronically ill individual. A chronically ill individual is a person who has been certified as one of the following:

  1. An individual who, for at least 90 days, is unable to perform at least two activities of daily living without substantial assistance due to loss of functional capacity. Activities of daily living are eating, toileting, transferring, bathing, dressing, and continence.
  2. An individual who requires substantial supervision to be protected from threats to health and safety due to severe cognitive impairment. The certification must have been made by a licensed health care practitioner within the previous 12 months.

Benefits received. For information on excluding from gross income benefits you receive from a long-term care contract, see Publication 525, Taxable and Nontaxable Income.

Limits. You cannot deduct an amount more than your net earnings from the trade or business in which the medical insurance plan or long-term care insurance plan is established. If the business in which the insurance plan is established is an S corporation, you cannot deduct more than your wages from the S corporation. Do not subtract the self-employed health insurance deduction when figuring net earnings for your self-employment tax. However, subtract the amount of this deduction from your medical insurance when figuring your medical expenses on Schedule A (Form 1040) if you itemize your deductions.

Other coverage. You cannot take the deduction for any month if you were eligible to participate in any employer (including your spouse's) subsidized health plan at any time during that month. This rule is applied separately to plans that provide long-term care insurance and plans that do not provide long-term care insurance. However, any medical insurance payments not deductible on line 27 of Form 1040 can be included as part of your medical expenses on Schedule A (Form 1040) if you itemize your deductions.

How to figure the deduction. Generally, you can use the worksheet in the Form 1040 instructions to figure your deduction. However, if either of the following applies, you must use the worksheet that follows.

  1. You have more than one source of income subject to self-employment tax, or
  2. You file Form 2555 or Form 2555-EZ (relating to foreign earned income).

Caution. If you have more than one health plan during the year, and each plan is established under a different business, you must use separate worksheets (in this chapter) to figure each plan's net earnings limit. Include your insurance payments under that plan on line 1 of the separate worksheet and your net profit (or wages) from that business on line 4 (or line 11).

Worksheet (Keep for your records.)

  1. Enter total payments made during the taxable year for health insurance coverage for yourself, your spouse, and your dependents. (Do not include payments for coverage for any month during which you were eligible to participate in a health plan subsidized by your or your spouse's employer.) ________
  2. Percentage used to figure deduction for 1998 _________
  3. Multiply amount on line 1 by the percentage on line 2 _________           
  4. Enter your net profit and any other earned income* from the trade or business under which the insurance plan is established. (If the business is an S corporation, skip to line 11.)            __________
  5. Enter the total of all net profits from: line 31, Schedule C (Form 1040); line 3, Schedule C-EZ (Form 1040); line 36, Schedule F (Form 1040); or line 15a, Schedule K-1 (Form 1065); plus any other income allocable to the profitable businesses. See the instructions for Schedule SE (Form 1040). (Do not include any net losses shown on these schedules.)            ___________
  6. Divide the amount on line 4 by the amount on line 5 ___________          
  7. Multiply the amount on Form 1040, line 26, by the percentage on line 6  _______         
  8. Subtract amount on line 7 from amount on line 4 ____________
  9. Enter the amount, if any, from Form 1040, line 28, attributable to the same trade or business in which the health insurance plan is established  ____________        
  10. Subtract the amount on line 9 from the amount on line 8 ____________       
  11. Enter your wages from your S corporation in which the health insurance plan is established            _____________
  12. Enter the amount from Form 2555, line 43, attributable to the amount entered on line 4 or 11 above, or the amount from Form 2555-EZ, line 18, attributable to the amount entered on line 11 above _____________
  13. Subtract the amount on line 12 from the amount on line 10 or 11, whichever applies  _____________
  14. Compare the amounts on lines 3 and 13 above. Enter the smaller of the two amounts here and on Form 1040, line 27. (Do not include this amount when figuring a medical expense deduction on Schedule A, Form 1040.) ______________

*Earned income includes net earnings and gains from the sale, transfer, or licensing of property you created. It does not include capital gain income.

Nondeductible Premiums

You cannot deduct the following kinds of insurance premiums.

  1. Self-insurance reserve funds. You cannot deduct amounts credited to a reserve you set up for self-insurance. This applies even if you cannot get business insurance coverage for certain business risks. However, your actual losses may be deductible. See Publication 547, Casualties, Disasters, and Thefts..
  2. Loss of earnings. You cannot deduct premiums for a policy that pays for your lost earnings due to sickness or disability. However, see the earlier discussion on overhead insurance, item (8), under Deductible Premiums.
  3. Certain life insurance and annuities. For contracts issued before June 9, 1997, you cannot deduct the premiums on a life insurance policy covering yourself, an employee, or any person with a financial interest in your business if you are directly or indirectly a beneficiary of the policy. For this purpose, you are included among possible beneficiaries of the policy if the policy owner is obligated to repay a loan from you using the proceeds of the policy. A person has a financial interest in your business if the person is an owner or part owner of the business or has lent money to the business. For contracts issued after June 8, 1997, you generally cannot deduct the premiums on any life insurance policy, endowment contract, or annuity contract, if you are directly or indirectly a beneficiary. The disallowance applies without regard to whom the policy covers.Partners. If, as a partner in a partnership, you take out an insurance policy on your own life and name your partners as beneficiaries to induce them to retain their investments in the partnership, you are considered a beneficiary. You cannot deduct the insurance premiums.
  4. Insurance to secure a loan. If you take out a policy on your life or on the life of another person with a financial interest in your business to get or protect a business loan, you cannot deduct the premiums as a business expense. Nor can you deduct the premiums as interest on business loans or as an expense of financing loans. In the event of death, the proceeds of the policy are not taxed as income even if they are used to liquidate the debt.

Capitalizing Premiums

Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for production or resale activities. Include these costs in the basis of property you produce or in inventory, rather than claiming them as a current deduction. Also, recover the costs through depreciation, amortization, cost of goods sold, or by an adjustment to basis when you use, place in service, or dispose of the property.

When the uniform capitalization rules apply. You must use the uniform capitalization rules if, in your trade or business or activity carried on for profit, you:

  1. Produce real property or tangible personal property for use in the business or activity,
  2. Produce real property or tangible personal property for sale to customers, or
  3. Acquire property for resale.

However, you generally do not have to use the uniform capitalization rules for personal property acquired for resale if your average annual gross receipts are not more than $10,000,000.

Indirect costs include premiums for insurance on your plant or facility, machinery, equipment, materials, property produced, or property acquired for resale.

When To Deduct Premiums

You can usually deduct insurance premiums in the tax year to which they apply.

Cash method. If you use the cash method of accounting, you must generally deduct insurance premiums in the tax year in which you actually pay them, even if you incurred them in an earlier year.

Accrual method. If you use an accrual method of accounting, you can generally deduct insurance premiums in the tax year in which you incur a liability for them, whether or not you pay them in the same year.

Cash or accrual method prepayments. You cannot deduct the entire premium for an insurance policy that covers more than one tax year in the year you make the payment or incur a liability for the payment. For the year in which you make the payment or incur the liability, you can deduct only the part of the premium that applies to that year. For each later tax year, you can deduct the part that applies to that tax year.

Example. You operate a business and file your returns on a calendar-year basis. You bought a fire insurance policy on your building effective October 1, 1997, and paid a premium of $1,200 for 2 years of coverage. On your 1997 return, you can deduct only the part of the total premium that applies to the 3 months of coverage in 1997. For 1998 and 1999, you can deduct the part of the premium that applies to each of those years. Since the total policy premium is $1,200 for 2 years, the yearly rate is $600 and the monthly rate is $50. For the 3-month period in 1997, you can deduct $150; for 1998, you can deduct $600; and for the 9-month period in 1999, you can deduct $450.

If you use the cash method of accounting and you pay the $1,200 premium in January 1998, you cannot deduct any amount on your 1997 return. However, you can deduct $750 (the $150 that applies to 1997 plus the $600 that applies to 1998) on your return for 1998.

Dividends received. If you receive dividends from business insurance and you deducted the premiums in prior years, part of the dividends are income.