Taxation of Business Overhead Policies
Understand the tax framework for business overhead policies, where deductible premiums correspond with taxable benefits used to cover operating costs.
A business overhead expense, or BOE, policy is a specific type of disability insurance. It is designed to cover the fixed operating costs of a business if an owner becomes disabled and is unable to work. Covered expenses typically include items like rent or mortgage payments, employee salaries and benefits, utilities, and property taxes. The policy is not meant to replace the owner’s personal income, but rather to keep the business financially stable.
Tax Deductibility of Premiums
The premiums paid for a business overhead expense policy are tax-deductible. They are considered an ordinary and necessary business expense. For a sole proprietor, this deduction would typically be claimed on Schedule C (Form 1040), Profit or Loss from Business. The ability to subtract the premium cost directly from the business’s gross income lowers its overall taxable income for the year. The business, not the individual owner, pays the premium and takes the deduction.
Taxability of Policy Benefits
When a business receives benefits from a BOE policy, those payments are considered taxable income. The business must report the benefit payments it receives as revenue. This is designed to work in tandem with the deductions the business continues to take for its regular operating expenses. The policy benefits are used to pay for these ongoing, deductible costs.
This structure creates what is often referred to as a “wash.” The taxable income from the insurance benefit is offset by the tax deductions claimed for paying the covered overhead expenses, such as rent and utilities. For example, if the business receives a $10,000 benefit and uses it to pay $10,000 in deductible expenses, the net effect on the business’s taxable income is zero.
A situation can arise where the monthly benefit paid by the policy exceeds the actual overhead expenses for that month. In this case, the excess amount is still considered taxable income. There is no corresponding expense deduction to offset this excess portion, resulting in an increase in the business’s taxable income for that period. Some policies may allow the business to carry forward unused benefits to cover months where expenses are higher than the standard monthly benefit.
Comparison with Personal Disability Insurance
The tax treatment for these two policies is different, reflecting their distinct purposes. Personal disability insurance is intended to replace a portion of an individual’s lost wages, providing funds for personal living costs. Premiums for an individual disability policy are typically paid with after-tax dollars, meaning the individual cannot deduct the premium cost from their personal income.
Because the premiums are not tax-deductible, the benefits received from a personal disability policy are generally tax-free. This is the direct opposite of a BOE policy, where premiums are deductible and benefits are taxable.
BOE insurance is a business tool, with its tax structure integrated into the finances of the business entity itself. Personal disability insurance, on the other hand, is a personal financial safety net, structured to provide tax-free income directly to the individual during a period of disablement.