Tax Treatment for Key Person Insurance

When Is Key Person Insurance Tax Deductible?

The taxation of different types of insurance cover can be confusing at the best of time. Whether you will pay tax for Keyman insurance will depend on the ownership structure and what the keyman insurance is actually used for.

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If key person insurance is taken out for capital purposes, it is non-deductible. In layman's terms, if the arrangement is unrelated to business, then it is not exempted. On the other hand, if the key man insurance is drawn out for revenue purposes - to replace the damage incurred by the loss of your key person, then it is tax deductible.

  • When is key person insurance tax deductible?
    • When it is used to compensate for the loss of profits and revenues of your company or business.
    • When it used to hire and train the replacement of your key person.
    • When it is used to pay the temporary replacement you have employed until there is full-time replacement found.
    • When it is used to pay debts incurred by the loss of your key person.
  • When is key person insurance not tax deductible?
    • When the benefit is used to pay the debts of a key person.
    • When the benefit is used to pay other debts incurred by the loss of the key person.
    • When the value of goodwill is replaced because of the absence of your key person.
    • When lines of credit are replaced guaranteed by your key person.

How is the benefit payment for Keyman Insurance taxed?

  • The benefit payment is not taxed if the benefit is paid to the original beneficiary of a life insurance policy
  • Claim payment may be subject to capital gains tax if the benefit is paid to the business or a trust for a life/accident/illness policy
  • Benefit payment is usually not taxed if paid to the life insured, relative or spouse of the life insured
Purpose and conditionsPremiums deductible?Benefits taxed?Benefits impacted by capital gains tax?
Revenue Purposes
  • Yes
  • Yes
  • No
Capital purposes
  • No
  • No
  • No
  • Only for business taxes
  • Only for business taxes
  • Benefits are subject to capital gains tax if the recipient is not business, and is not a relative of the key person

What exactly is Key Person Insurance?

Key person insurance is a type of insurance product that helps cover your business for whatever unexpected things that might happen. Key person insurance will protect your business from financial loss if your key person suddenly leaves or is gone. Aside from protecting your business, key person insurance can provide the funds you need for hiring a new employee and many other needs.

  • It protects your profits - Key person insurance pays you a lump sum benefit which you can use while looking for a replacement. Thus, instead of using money from your company's coffers, you can use the benefit to pay for the process.
  • It helps pay your debts - Debts can never be prevented and not bad if used wisely. In fact, most companies get a loan from a bank to expand their businesses. However, if your company's profits will be put in a very delicate position because of the loss of your key person, you can use the benefit to pay your debts and normalise the company.
  • It covers your liquid assets - Liquid assets are your assets that can be converted to cash. However, some companies have problems with liquidity which can worsen with the loss of your key person. With key person insurance, the benefits you will receive from this policy will help cover the financial loss brought by the loss of your key person

The tax deductibility of your key man insurance will depend on what purpose you have arranged it to be. The best thing for you to do is ask your financial adviser or accountant before drawing up key man insurance.

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DISCLAIMER: This article contains general advice and does not consider your own personal circumstances. It is not tax advice and the general nature of this material may not be applicable to you. You should obtain professional advice and verify our interpretation before relying on the information contained in our article.

Maurice Thach

An insurance researcher and writer for who loves finding an answer to the question "Am I covered for ________?" Maurice has also completed a Tier 1 Life Insurance and a Tier 2 General Insurance Certification under ASIC's Regulatory Guide 146. This means he can confidently provide general advice for life insurance and non-life insurance products.

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