Is Malpractice Insurance Tax Deductible?

Malpractice insurance, a type of professional liability coverage, protects individuals and businesses from financial losses arising from claims of negligence, errors, or omissions in their professional services. The ability to deduct the premiums paid for this insurance on your taxes depends significantly on your employment status and how your business is structured. Understanding these distinctions is important for managing your tax obligations.

Deductibility for Self-Employed Individuals and Businesses

For self-employed professionals, such as sole proprietors, independent contractors, and owners of businesses like partnerships, LLCs, S-corporations, or C-corporations, malpractice insurance premiums are generally tax-deductible. The Internal Revenue Service (IRS) considers these premiums an “ordinary and necessary” business expense. An ordinary expense is common and accepted in your industry, while a necessary expense is helpful and appropriate for your trade or business.

These deductible premiums directly reduce your gross income, which in turn lowers your taxable business income. For sole proprietors, these expenses are typically reported on Schedule C of Form 1040. Partnerships and corporations report these expenses on their respective business tax forms, such as Form 1120 for C-corporations or Form 1120-S for S-corporations.

Deductibility for Employees

The tax treatment of malpractice insurance premiums for individuals who are employees (receiving a W-2) differs significantly from that of self-employed individuals. Before the Tax Cuts and Jobs Act (TCJA) of 2017, employees could deduct unreimbursed business expenses, including malpractice insurance premiums, as an itemized deduction on Schedule A (Form 1040).

However, under current federal tax law, the TCJA eliminated the deduction for unreimbursed employee business expenses for tax years 2018 through 2025. This means employees who pay for their own malpractice insurance and are not reimbursed by their employer can no longer deduct these premiums for federal income tax purposes. While some states may still permit such deductions on their state income tax returns, the federal landscape has changed.

Understanding Qualified Business Income Deduction

Malpractice insurance premiums, when deducted as a business expense, can indirectly influence the Qualified Business Income (QBI) deduction, also known as the Section 199A deduction. This deduction allows eligible self-employed individuals and owners of pass-through entities to deduct up to 20% of their qualified business income. The QBI deduction is calculated based on your net business income.

Since malpractice insurance premiums are considered a business expense, they reduce your net business income. A lower net business income means a lower amount upon which the QBI deduction is calculated. Therefore, while these premiums do not directly qualify as a QBI deduction, they effectively lower the taxable income used for its calculation, potentially impacting the final QBI deduction amount.

Record Keeping

Maintaining accurate and organized records is important when deducting malpractice insurance premiums. The IRS requires taxpayers to keep records that support the deductions claimed on their tax returns. These records should clearly show the amount paid, the business reason for the payment, and proof of payment.

Essential documents to retain include cancelled checks, bank statements, credit card statements, and the actual insurance policy documents or premium invoices. Taxpayers should keep these records for at least three years from the date they filed their original return or two years from the date they paid the tax, whichever is later, for potential IRS audits or inquiries. Proper record keeping ensures you can substantiate your deductions if questioned.