Benjamin Franklin said it best. “Death and Taxes.” The two things you can count on in life. And I don’t know of anybody getting out of this world without confronting both of them. Still, it is fairly common for people to attempt to pay their life insurance premiums with dollars that they haven’t paid taxes on yet, hoping that they might be able to avoid some taxes on the compounding annual growth of the cash values that build in participating life insurance policies.
As great as this sounds here are 4 ramifications that you should consider before you make things more difficult for yourself than you ought.
Policy(s) Owned by a C Corporation
If you are paying premiums from the corporation then:
The premium is non-deductible.
Form 1120 (net income) must be filed and premiums will be taxed to the C Corp at C Corp Tax Rates somewhere between 15% and 39% at the time of this writing.
If the Policy(s) are Owned personally by the C Corp owner/employee
C Corp deducts premium
Owner/employee pays taxes on premium as “bonus” income and all taxes must be withheld on both corporate and personal levels.
C Corp owner can make dividend withdraw to meet premiums from retained earnings.
This is considered a dividend distribution and in not deductible to the C Corp.
Dividend income is taxed from 15% to 39.6% and could have Medicare tax of 3.8% on top of that if your adjusted gross income is above $200,000 annually.
For Policy(s) Owned by an S Corp
The premium is non-deductible
Form 1120S (net income) must be filed and will pass-through on the K-1 as income to the S Corp owner and reported on Schedule E of the 1040 Tax Return
For Policy(s) owned by the S Corp owner/employee
Premiums can be paid as bonus compensation to the owner/employee
The premium will be considered earned income personally and all taxes must be paid on the corporate and personal level.
If premiums are paid from “pass-through” profits, then premiums could be considered “unearned passive income” and avoid the FICA taxes associated with “earned income.”
If the S Corp has an Accumulated Adjustments Account…a previous year(s) taxed earning account, also known as an AAA…then a tax-free withdraw can be made to pay for personal insurance on the S Corp owner. There is no FICA tax on AAA withdrawals because these funds have in a previous year been taxed as “unearned income”.
Of course, LLCs are just a hybrid of partnerships and corporations and can choose to file their tax return either as a C Corp, S Corp, Partnership or Sole proprietor. And therefore the above 4 rules will apply accordingly.
So the good news is: Because distributions from an S Corp are not considered “earned income” by the IRS but rather “passive income” there is a tax advantage in paying life insurance premiums from a distribution(s) either from your S Corp or LLC that has elected to file taxes as an S Corp. Other than that, Buyer beware! Because “Death and Taxes” are two things that you can count on in this life. And by the way, the death benefit from a life insurance policy is never taxed by the IRS unless it makes your estate value exceed $5.45million (at the time of this writing.) But be aware of states that have bitterly high estate tax. You may be better off with a Trust as the beneficiary of your life insurance policy rather than leaving it directly to your loved ones.
For more information, call Life Benefits at 702-660-7000. We can help.