Is Workers Compensation Tax Deductible?

Workers’ compensation insurance premiums are tax-deductible. The Internal Revenue Service (IRS) allows companies to deduct these payments as a business expense. This deduction helps lessen the financial impact of this often-mandatory coverage by lowering a company’s overall tax liability.

Deducting Workers Compensation Premiums

The IRS permits businesses to deduct workers’ compensation insurance premiums because they qualify as an “ordinary and necessary” business expense. An ordinary expense is common in your industry, while a necessary expense is helpful for your business. Since state laws mandate workers’ compensation coverage for businesses with employees, the premiums paid for this insurance meet both definitions.

This deduction applies to premiums your business pays to a private insurance company for a policy covering your employees and corporate officers. The timing of the deduction depends on your business’s accounting method. If you use the cash method, you can only deduct premiums in the tax year you pay them. For businesses using the accrual method, the deduction is taken in the tax year the expense is incurred, regardless of when payment is made.

If you pay for a policy that covers more than one tax year, you cannot deduct the entire premium in the year you paid it. You must capitalize the cost and allocate the premium deduction to each respective year the policy covers. For example, if you pay for a three-year policy upfront, you can only deduct one-third of the total premium on each of the three corresponding tax returns.

How to Report the Deduction for Different Business Structures

The specific tax form used to claim the deduction for workers’ compensation premiums depends on how your business is legally structured. Each entity type has a designated place to report this expense for accurate tax filing.

Sole Proprietorships and Single-Member LLCs

Individuals who operate as sole proprietors or own a single-member LLC taxed as a disregarded entity report the deduction on their personal tax return. These business owners must file Schedule C (Form 1040), Profit or Loss from Business. The cost of workers’ compensation insurance premiums is entered on Line 15, which is for “Insurance (other than health).”

Partnerships and Multi-Member LLCs

A partnership or a multi-member LLC taxed as a partnership reports its business expenses on Form 1065, U.S. Return of Partnership Income. The deduction for workers’ compensation premiums is included under the category of “Other deductions.” The partnership must attach a statement to the return detailing these other deductions, where the insurance cost would be itemized.

S Corporations

S corporations file their income tax returns using Form 1120-S, U.S. Income Tax Return for an S Corporation. The deduction for workers’ compensation premiums is reported as an “Other deduction.” This is detailed on an attached statement, with the total flowing to Line 19 of Form 1120-S. If an S corporation pays premiums for a shareholder-employee who owns more than 2% of the company stock, the premium amount must also be included in that shareholder’s wages on their Form W-2, though it is exempt from Social Security and Medicare taxes.

C Corporations

C corporations report their income and deductions on Form 1120, U.S. Corporation Income Tax Return. The cost of workers’ compensation insurance premiums is claimed in the “Deductions” section. This expense is included on Line 26, “Other deductions,” and should be detailed in an attached statement.

Handling Self-Insurance and State Fund Payments

Not all businesses purchase workers’ compensation from a private insurer; some are self-insured or pay into state-administered funds. The tax treatment for these arrangements differs.

For businesses that are self-insured, a deduction cannot be taken for money set aside in a reserve fund to cover potential future claims. The IRS does not permit a deduction for anticipated liabilities. Instead, the business can only deduct the actual amounts paid out for workers’ compensation claims to injured employees during that specific tax year.

In contrast, payments made to a state-administered workers’ compensation fund are treated in the same manner as premiums paid to a private insurance company. These payments are fully deductible as a business expense in the year they are paid or incurred, depending on the business’s accounting method. This applies to businesses in jurisdictions where participation in a state fund is mandatory or optional.

Non-Deductible Related Expenses

While workers’ compensation premiums are deductible, certain related costs are not. Any fine or penalty paid to a government agency for non-compliance with workers’ compensation laws is not a deductible business expense under IRS Code Section 162. For example, if a state imposes a penalty on your business for failing to maintain required coverage, that payment is not deductible.