How are key person life insurance policy premiums and death benefits taxed?

In the context of key person life insurance, premiums are not deductible as a business expense, and the death benefits paid out to the business are generally not taxable. Key person insurance is designed to protect a business against the financial loss that can occur when a key employee passes away.

The premiums paid for such a policy are considered a business expense, but the IRS does not allow businesses to deduct these premiums. This is because the life insurance policy is ultimately a form of risk management rather than a business expense that provides a direct economic benefit at the time of payment.

When the insured key person dies, the death benefit paid out to the business is received tax-free. This tax advantage is beneficial for the company, as it means they receive the full amount of the insurance payout without the burden of taxation, allowing them to use these funds effectively to cover any financial impact caused by the loss of the key employee.

This understanding clarifies how both premiums and death benefits function concerning taxation in key person policies, illustrating the unique tax treatment these insurance arrangements receive.