Publication 535 (2005), Business Expenses

7. Insurance

Table of Contents

Introduction

You generally can deduct the ordinary and necessary cost of insurance as a business expense if it is for your trade, business, or profession. However, you may have to capitalize certain insurance costs under the uniform capitalization rules. For more information, see Capitalized Premiums, later.

Topics - This chapter discusses:

Deductible premiums
Nondeductible premiums
Capitalized premiums
When to deduct premiums

Useful Items - You may want to see:

Publication

15-B Employer's Tax Guide to Fringe Benefits
525 Taxable and Nontaxable Income
538 Accounting Periods and Methods
547 Casualties, Disasters, and Thefts

Form (and Instructions)

1040
U.S. Individual Income Tax Return

See chapter 14 for information about getting publications and forms.

Deductible Premiums

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

Insurance that covers fire, storm, theft, accident, or similar losses.
Credit insurance that covers losses from business bad debts.
Group hospitalization and medical insurance for employees, including long-term care insurance.
1. If a partnership pays accident and health insurance premiums for its partners, it generally can deduct them as guaranteed payments to partners.
2. If an S corporation pays accident and health insurance premiums for its 2% shareholder-employees, it generally can deduct them, but must also include them in the shareholder's wages subject to federal income tax withholding. See Publication 15-B.
Liability insurance.
Malpractice insurance that covers your personal liability for professional negligence resulting in injury or damage to patients or clients.
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 generally can deduct them as guaranteed payments to partners.
2. If an S corporation pays workers' compensation premiums for its 2% shareholder-employees, it generally can deduct them, but must also include them in the shareholder's wages.
Contributions to a state unemployment insurance fund are deductible as taxes if they are considered taxes under state law.
Overhead insurance that pays for business overhead expenses you have during long periods of disability caused by your injury or sickness.
Car and other vehicle insurance that covers vehicles used in your business for liability, damages, and other losses. If you operate a vehicle partly for personal use, deduct only the part of the insurance premium 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.
Life insurance covering your officers and employees if you are not directly or indirectly a beneficiary under the contract.
Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause.

Self-Employed Health Insurance Deduction

You may be able to deduct 100% of the amount paid for medical and dental insurance and qualified long-term care insurance for you, your spouse, and your dependents if you are one of the following.

A self-employed individual with a net profit reported on Schedule C, C-EZ, or F.
A partner with net earnings from self-employment reported on Schedule K-1 (Form 1065), box 14, code A.
A shareholder owning more than 2% of the outstanding stock of an S corporation with wages from the corporation reported on Form W-2.

The insurance plan must be established under your business. You may be 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 the deduction on line 29 of Form 1040.

Qualified long-term care insurance. You can include premiums paid on a qualified long-term care insurance contract for you, your spouse, or your dependents when figuring your deduction. But, for each person covered, you can include only the smaller of the following amounts.

The amount paid for that person.
The amount shown below. (Use the person's age at the end of the year.)
1. Age 40 or younger-$270
2. Age 41 to 50-$510
3. Age 51 to 60-$1,020
4. Age 61 to 70-$2,720
5. Age 71 or older-$3,400

Qualified long-term care insurance contract. A qualified long-term care insurance contract is an insurance contract that only provides coverage of qualified long-term care services. The contract must meet all the following requirements.

It must be guaranteed renewable.
It must 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.
It must not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed.
It generally must 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. Qualified long-term care services are:

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

The services must be 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.

An individual who has been unable, due to loss of functional capacity for at least 90 days, to perform at least two activities of daily living without substantial assistance from another individual. Activities of daily living are eating, toileting, transferring (general mobility), bathing, dressing, and continence.
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 benefits you receive from a long-term care contract from gross income, see Publication 525.

Other coverage. You cannot take the deduction for any month 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 29 of Form 1040 can be included as medical expenses on Schedule A (Form 1040) if you itemize deductions.

Effect on itemized deductions. Subtract the health insurance deduction from your medical insurance when figuring medical expenses on Schedule A (Form 1040) if you itemize deductions.

Effect on self-employment tax. Do not subtract the health insurance deduction when figuring net earnings for your self-employment tax.

How to figure the deduction. Generally, you can use the worksheet in the Form 1040 instructions to figure your deduction. However, if any of the following apply, you must use the worksheet in this chapter.

You had more than one source of income subject to self-employment tax.
You file Form 2555 or Form 2555-EZ (relating to foreign earned income).
You are using amounts paid for qualified long-term care insurance to figure the deduction.

If you are claiming the health coverage tax credit, complete Form 8885 before you figure this deduction.

Health coverage tax credit. You may be able to take this credit only if you were an eligible trade adjustment assistance (TAA) recipient, alternative TAA recipient, or Pension Benefit Guaranty Corporation pension recipient. Use Form 8885, Health Coverage Tax Credit, to figure the amount, if any, of your health insurance credit.

More than one health plan and business. 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 (Worksheet 7-A) to figure each plan's net earnings limit. Include the premium you paid under each plan on line 1 or line 2 of that separate worksheet and your net profit (or wages) from that business on line 4 (or line 11). For a plan that provides long-term care insurance, the total of the amounts entered for each person on line 2 of all worksheets cannot be more than the appropriate limit shown on line 2 for that person.

Nondeductible Premiums

You cannot deduct premiums on the following kinds of insurance.

Self-insurance reserve funds. You cannot deduct amounts credited to a reserve 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.
Loss of earnings. You cannot deduct premiums for a policy that pays for lost earnings due to sickness or disability. However, see the discussion on overhead insurance, item (8), under Deductible Premiums, earlier.
Certain life insurance and annuities.
1. For contracts issued before June 9, 1997, you cannot deduct the premiums on a life insurance policy covering you, an employee, or any person with a financial interest in your business if you are directly or indirectly a beneficiary of the policy. 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.
2. 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.
3. 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.
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.

Capitalized Premiums

Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property.

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

Uniform capitalization rules. You may be subject to the uniform capitalization rules if you do any of the following, unless the property is produced for your use other than in a business or an activity carried on for profit.

Produce real property or tangible personal property. For this purpose, tangible personal property includes a film, sound recording, video tape, book, or similar property.
Acquire property for resale.

However, these rules do not apply to the following property.

Personal property you acquire for resale if your average annual gross receipts are $10 million or less for the 3 prior tax years.
Property you produce if you meet either of the following conditions.
1. Your indirect costs of producing the property are $200,000 or less.
2. You use the cash method of accounting and do not account for inventories.

More information. For more information on these rules, see Uniform Capitalization Rules in Publication 538 and the regulations under Internal Revenue Code section 263A.

Worksheet 7-A. Self-Employed Health Insurance Deduction Worksheet (Keep for your records.)

1.	Enter total payments made during the year for health insurance coverage established under your business for you, your spouse, and your dependents. (Do not include payments for any month you were eligible to participate in a health plan subsidized by your or your spouse's employer or any amount you claim on line 4 of Form 8885. Also, do not include payments for qualified long-term care insurance.)			1.
2.	For coverage under a qualified long-term care insurance contract, enter for each person covered the smaller of the following amounts.
	a)	Total payments made for that person during the year.
	b)	The amount shown below. (Use the person's age at the end of the year.)
		$270—	if that person is age 40 or younger
		$510—	if age 41 to 50
		$1,020—	if age 51 to 60
		$2,720—	if age 61 to 70
		$3,400—	if age 71 or older
		(Do not include payments for any month you were eligible to participate in a long-term care insurance plan subsidized by your or your spouse's employer.) If more than one person is covered, figure separately the amount to enter for each person. Then enter the total of those amounts		2.
3.	Add the total of lines 1 and 2			3.
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.)			4.
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 box 14, code A, 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.)			5.
6.	Divide line 4 by line 5			6.
7.	Multiply Form 1040, line 27 by the percentage on line 6			7.
8.	Subtract line 7 from line 4			8.
9.	Enter the amount, if any, from Form 1040, line 28, attributable to the same trade or business in which the insurance plan is established			9.
10.	Subtract line 9 from line 8			10.
11.	Enter your wages from an S corporation in which you are a more-than-2% shareholder and in which the insurance plan is established			11.
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			12.
13.	Subtract line 12 from line 10 or 11, whichever applies			13.
14.	Compare the amounts on lines 3 and 13 above. Enter the smaller of the two amounts here and on Form 1040, line 29. (Do not include this amount when figuring a medical expense deduction on Schedule A (Form 1040).)			14.
* If you used either optional method to figure your net earnings from self-employment from any business, do not enter your net profit from the business. Instead, enter the amount attributable to that business from Schedule SE, line 4b.
* *Earned income includes net earnings and gains from the sale, transfer, or licensing of property you created. It does not include capital gain income.

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 generally deduct insurance premiums in the tax year you actually paid them, even if you incurred them in an earlier year. However, see Prepayment, later.

Accrual method. If you use an accrual method of accounting, you cannot deduct insurance premiums before the tax year in which you incur a liability for them. In addition, you cannot deduct insurance premiums before the tax year in which you actually pay them (unless the exception for recurring items applies). For more information about the accrual method of accounting, see chapter 1. For information about the exception for recurring items, see Publication 538.

Prepayment. You cannot 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.

Example.

In 2005, you signed a 3-year insurance contract. Even though you paid the premiums for 2005, 2006, and 2007 when you signed the contract, you can only deduct the premium for 2005 on your 2005 tax return. You can deduct in 2006 and 2007 the premium allocable to those years.

Dividends received. If you receive dividends from business insurance and you deducted the premiums in prior years, at least part of the dividends generally are income. For more information, see Recovery of amount deducted (tax benefit rule) in chapter 1 under How Much Can I Deduct?