F—Tax Treatment Of Premium Payments
As a general rule, premiums for life insurance are not deductible for income tax purposes.
Premiums paid by the insured for personal life insurance policies are considered personal expenses and therefore are not deductible from gross income [I.R.C. §262; James Kutz, 5 B.T.A. 239]. It is immaterial whether the insurance is government life insurance or commercial life insurance. This same rule applies to an employee`s contribution to group life insurance [Austin T. Flett, 19 T.C.M. 825].
Business Life Insurance
Generally, a corporation cannot take a deduction for premiums paid if it is either directly or indirectly a beneficiary under the policy. [I.R.C. §264(a)(1)]. Thus, if a corporation purchases a life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer it will typically be both owner and beneficiary of the policy. The deduction is also prohibited where the corporation only has some beneficial interest in the policy (but not as a named beneficiary). For example, a corporation may have the right to change the beneficiary, make loans or surrender the policy for cash. In these cases, no deduction is allowed.
However, corporations often purchase life insurance for their employees where the proceeds are payable to the employee`s estate or named beneficiary. In this case, because the corporation has no ownership rights or beneficial interest in the policy, it can deduct the premiums as a business deduction under Code §162 for ordinary and necessary expenses incurred in carrying on a trade or business.
A taxpayer who takes out a policy of life insurance in favor of a creditor in order to procure a loan and as security therefor is not entitled to deduct the premiums paid on such policy [Rev. Rul. 68-5, 1968-1 C.B. 99]. Since the death proceeds will be used to discharge the debtor`s obligations, the insured is the indirect beneficiary [I.R.C., §264(a)(1); Rieck v. Heiner, 25 F.2d 453, cert. denied 277 U.S. 608; Jefferson v. Helvering, 121 F.2d 16; Ragan v. Comm`r, 40 T.C.M. 13 (1980)]. If the debt is a business debt, a deduction is also not allowable as a business expense or otherwise [Richard M. Glassner, 43 T.C. 713, aff`d 360 F.2d 33 (on another issue)].
Such premiums are nondeductible even where the insured debtor was required to purchase and maintain the policy in order to obtain the loan [Jefferson v. Helvering, 121 F.2d 16; Klein v. Comm`r, 84 F.2d 310; Joseph J. O`Donohue, 33 T.C. 698; Roy H. King, 22 T.C.M. 1344].
Likewise, where the borrower pledges existing insurance upon his life as collateral security for a loan, the premiums are not deductible. [Warren Leslie, Sr., 6 T.C. 488].
If a creditor voluntarily purchases, owns and is the beneficiary of insurance on a debtor`s life, premiums paid by the creditor are not deductible for income tax purposes [I.R.C. §§262, 264(a)(1)], and the proceeds are exempt [I.R.C. §101(a)(1); Durr Drug Co. v. U.S., 99 F.2d 757].
If a debtor assigns his insurance policy to his creditor as collateral, and the creditor pays premiums on it, a special problem arises. Whether a creditor can take an income tax deduction for the amount of premiums paid depends upon whether the loan is a business or personal one.
Generally, the debt must be worthless or uncollectible before the creditor can deduct the premiums paid, regardless of the creditor`s ability to recover the premiums from the cash surrender value [Comm`r v. Charleston Nat`l Bank, 213 F.2d 45 (CA-4, 1954); Dominion Nat`l Bank v. Comm`r, supra]. However, the IRS position, which differs somewhat from the courts` position allows the creditor to deduct the premium payments when there is no right of reimbursement from the debtor-either under the terms of the loan, the assignment, or state law-and the right to be reimbursed from policy proceeds is worthless, because the debt is greater than the cash surrender value of the policy [Rev. Rul. 75-46, supra].
However, the courts have held that a creditor can take a deduction as an ordinary and necessary business expense incident to the protection of the collateral [First Nat`l Bank & Trust Co. of Tulsa v. Jones, 143 F.2d 652 (CA-10, 1944); Dominion Nat`l Bank v. Comm`r, 26 B.T.A. 421 (1932), Lock, Moore, & Co. Ltd. v. Comm`r, 7 B.T.A. 1008 (1927); Rev. Rul. 75-46, 1975-1 C.B. 55].
If a creditor pays premiums on a policy securing a non-business debt, then premium payments are not deductible as ordinary and necessary business expenses under Code §162. According to the courts, because such expenses are not incurred to produce or collect income, they are considered to be a capital investment. The creditor cannot deduct the premium payments unless he has a worthless right to reimbursement.
An insured can take a charitable deduction for premiums paid on a policy owned by a charitable organization, subject to the annual limitations on the amount of the charitable deduction [I.R.C. §170; Eppa Hunton IV, 1 T.C. 821].
Where an insured irrevocably assigns a new policy to charity, and pays the initial premium the same day, the premium is deductible [Rev. Rul. 58-372, 1958-2 C.B. 99].
Note that the manner in which the premium payments are made could affect the applicable limitation on deductibility. The income tax deduction for contributions to a qualified public charity is generally limited to 50 percent of the taxpayer`s AGI, but in the case of contributions which are not to the charity but merely for the use of the charity, the lower 30 percent limit is applicable. If the donor/taxpayer pays the insurance premiums directly to the insurance company, this is not considered a gift to the charity which owns the policy, but rather a gift for the use of the charity. Thus, the 30 percent limitation is applicable. On the other hand, if the funds for the payment of premiums are paid by the donor to the charity, and the charity makes the payment to the insurance company, this would be a gift to the charity, and the higher 50 percent limitation would apply. Thus, attention to this substantively meaningless procedural distinction could make a difference in the case of a taxpayer whose overall charitable contributions are sufficiently high as to be affected by these deduction limitations.