Understanding Key Person Insurance: A Guide to Tax Deductions

The success and financial stability of a business can often hinge on the contribution of a single individual or a select few. In such situations, the adverse impact of serious illness or an unfortunate accident befalling these pivotal players could be substantial. This is were key person insurance steps in, acting as a financial safety net. Let’s look at what this means for your business and explore the nuances of claiming a tax deduction on such premiums.

Safeguarding Your Business’s Earnings: The Role of Key Person Insurance

Key person insurance is a strategic move for businesses that find their profitability tightly linked to specific individuals. By securing a policy, you’re insuring against potential losses in profits that could arise from the critical illness, injury, or even the demise of a crucial team member.

Deducting Premiums: Navigating the Rules

When it comes to the premiums paid for key person insurance, the rule of thumb is clear: they are deductible as long as they are incurred entirely and exclusively for the business’s purposes. This essentially means that the primary intent behind securing the insurance must be to offset the potential loss in trading income due to the key person’s inability to contribute to the business.

Deciphering whether this ‘sole purpose’ condition is met hinges on a factual examination. It requires looking closely at the objectives that the company directors, or proprietors in the case of a non-incorporated entity, had in mind when opting for the insurance policy.

It’s crucial to highlight scenarios where the premium may not qualify as a deductible business expense. For instance, if a policy is secured with an eye on protecting the share value, particularly for director-shareholders, the premium would not qualify. This is also applicable if the insurance policy is meant to secure the estate of the insured in the event of their demise.

When we talk about life assurance policies as a form of key person insurance, the waters become a tad more specific. The premiums are deductible only if it’s a term policy, covering the risk of death within a specific period and offering no other benefits. The term of the policy should not surpass the period during which the insured is deemed valuable to the company.

Loan-Linked Key Person Policies: A Word of Caution

A particular area that necessitates careful consideration is when key person insurance is tied to long-term financing. HMRC has clarified their stance: for non-incorporated entities, such premiums do not fall under incidental costs of loan finance and are, therefore, not deductible. The rule differs for companies, where loan relationship rules come into play.

Receiving Insurance Pay outs: The Tax Implications

When a pay out is received from a deductible premium, it’s considered a taxable trading receipt. Conversely, if the premium was not deductible (as is the case with loan-related policies), the pay out stays out of the taxable income equation.

In essence, navigating the world of key person insurance demands a keen eye on both the purpose behind securing the policy and the nature of the policy itself. By ensuring that these align with the trade needs and adhere to tax regulations, businesses can not only safeguard their financial stability but also optimize their tax position.

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Any questions?

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