It always pays to know what tax deductions you can make as a small business owner. In fact, do you know if you are missing some deductions for the business insurance policies you carry?
Is business insurance tax deductible?
Generally, yes, according to the Internal Revenue Service. If you operate a for-profit business, "generally, you can deduct the ordinary and necessary cost of insurance as a business expense, if it is for your trade, business, or profession."
"The most common mistake I see is that small business owners forget to deduct their self-employed health insurance," Gabriel Sandler, enrolled agent and financial advisor at Wolverine Tax and Financial, told business.com. "This can include out-of-pocket premiums covering their whole families, Medicare premiums, and even long-term care insurance."
Business owners don't often forget to deduct general liability insurance, Sandler said, "but it is important to remember that if you maintain a home office and use the actual expense method, a portion of your homeowners insurance should be included on Form 8829. … I do [also] often see small businesses with employees forget to deduct their workers' compensation insurance."
Unfortunately, as Sandler noted, disability insurance for yourself or your employees is not generally deductible.
What types of insurance payments (premiums) can businesses write off?
In general, you can deduct the following common commercial insurance policies, as listed in IRS Publication 535, Business Expenses.
- General liability insurance: This covers third-party liability claims for injuries to other people.
- Commercial property insurance: This covers loss and damage to your commercial business property due to fires, storms, and other causes.
- Business owners policy: A business owners policy includes commercial liability, commercial property and business interruption insurance.
- Business interruption insurance: This pays for lost profits if your business shuts down because of a fire or other cause.
- Professional liability insurance: This covers professionals against loss due to negligent professional duty, wrongful acts, and advice and services that lead to another person's loss or injury. This can consist of errors and omissions (E&O) coverage and/or malpractice insurance (for healthcare professionals).
- Cybersecurity insurance: This provides protection for risks due to internet use and online communications.
- Workers' compensation insurance: This is set by state law that covers any workers' comp claims for bodily injuries or job-related diseases that employees of your business incur, regardless of fault.
- If a partnership pays workers' compensation premiums for its partners, it generally can deduct them as guaranteed payments to partners.
- If an S corporation pays workers' compensation premiums for its over-2% shareholder-employees, it generally can deduct them, but it also must include them in the shareholder's wages.
- Health insurance: This provides medical coverage for your employees. If your business operates on a cash basis, you may only deduct insurance premium payments applicable to that year. For premiums paid quarterly in 2021, you may only deduct that portion of the premium of the quarterly premiums paid during 2021, for example, under the cash accounting method (see accounting methods discussed below, under "How can a business deduct premiums?").
- Life insurance: This covers your officers and employees if you aren't a direct or indirect beneficiary under the contract.
- Car insurance: If you use a car exclusively for your business, you can deduct the car insurance premiums and expenses that go beyond your deductible.
- Commercial surety bonds: These are used within professional industries to meet certain obligations, such as obtaining licenses required for your business (a real estate or mortgage broker license, for example).
- Builder's risk insurance or construction bonds: This protects businesses like construction companies and contractors who are insured against financial losses arising from the course of construction.
- State unemployment benefit contributions: Contributions to a state unemployment insurance fund are deductible if they are considered taxes under state law.
- Performance bonds or fidelity bonds: This includes fidelity bond coverage for employee theft and performance bonds for construction contracts.
- Home insurance: If you have a home-based business, and you use your home office space exclusively and regularly for your trade or business, you may be able to deduct a portion of the property insurance on your home.
- Credit insurance: This covers losses from business bad debts.
- Overhead insurance: This pays for your business overhead expenses during long periods of disability due to injury or sickness.
- Group hospitalization and medical insurance for employees: This includes long-term care insurance.
- If a partnership pays accident and health insurance premiums for its partners, it generally can deduct them as guaranteed payments to partners, according to the IRS.
- If an S corporation pays accident and health insurance premiums for its over-2% shareholder-employees, it generally can deduct them, but it also must include them in the shareholder's wages (subject to federal income tax withholding).
- Sick pay compensated by insurance: You can deduct amounts you pay to your employees for sickness and injury, including lump-sum amounts, as wages. However, your deduction is limited to amounts not compensated by insurance or other means.
These are the most common premiums that can be deducted from your taxes, but this is not an exhaustive list. You can always find the latest specifics on IRS.gov. Speak with your insurance agent and tax advisor for a complete list of premiums and insurance-related costs that your business can deduct.
What can't a business deduct?
According to the IRS regulations for 2021, businesses generally can't deduct the following costs.
- Prepaid insurance expenses: You generally cannot deduct expenses in advance, even if you pay them in advance. This applies to prepaid insurance premiums.
- Life insurance coverage: You can't deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest in your business if you're a direct or indirect beneficiary of the policy.
- Interest on loans with respect to life insurance policies: You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual, unless that individual is a key person in your business.
- Interest allocated to unborrowed policy cash value: Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee or 20% owner.
- Self-insurance reserve funds: You can't deduct amounts credited to a reserve set up for self-insurance. This applies even if you can't get business insurance coverage for certain business risks. However, your actual losses may be deductible.
- Dividends from business insurance: If you receive dividends from business insurance and you deducted the premiums in prior years, at least part of the dividends generally are income.
How can a business deduct premiums?
This depends on your accounting method. Businesses can usually deduct insurance premiums in the tax year to which they apply. The IRS discusses both the cash method and the accrual method.
- Cash method: According to the IRS, if you use the cash method of accounting, you generally deduct insurance premiums in the tax year you actually paid them, even if you incurred them in an earlier year.
- Accrual method: If you use an accrual method of accounting, you can't deduct insurance premiums before the tax year in which you incur a liability for them. You also can't deduct insurance premiums before the tax year in which you actually pay them (unless the exception for recurring items applies).
Can you deduct premiums in advance?
No. According to the IRS, "You can't deduct expenses in advance, even if you pay them in advance. This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Expenses such as insurance are generally allocable to a period of time. You can deduct insurance expenses for the year to which they are allocable."
The IRS gives the following example: "In 2020, you signed a 3-year insurance contract. Even though you paid the premiums for 2020, 2021, and 2022 when you signed the contract, you can only deduct the premium for 2020 on your 2020 tax return. You can deduct in 2021 and 2022 the premium allocable to those years."
As always, check with your accountant if you have specific questions. Also note that these IRS publications apply to 2021 and this is just an overview. For more details, consult a tax professional or visit IRS.gov.