Tax Status of Business-related Disability Coverage

Overhead Expense Policies

The tax treatment that is afforded certain specialty disability policies is not entirely consistent with the tax treatment given to disability income insurance policies.  This difference is readily apparent in Overhead Expense policies.  

The premiums paid for overhead expense policies are tax deductible, regardless of the type of organization that pays them.  The sole proprietorship, partnership and corporation all enjoy the tax-deductibility of Overhead Expense policy premiums.  

Consistent with the general rule concerning disability insurance taxation, the Overhead Expense benefits are considered taxable income when they are received.  However, because Overhead Expense benefits are reimbursement benefits that are received for tax-deductible business expenses that have already been paid by the policyowner, the net tax treatment is a wash.  While the benefits are taxable, the paid expenses are deductible.

Disability Buyout & Keyperson Policies

In the case of disability buyout and keyperson disability policies, the premium payor and the beneficiary are the same entity.  As a result, they share the same tax treatment given to personally owned disability income insurance policies.  Both disability buyout policies and key person disability policies enjoy tax-free benefits, but the premiums are paid with after-tax dollars.  Since the business is both premium payor and beneficiary of these policies, the tax treatment necessarily follows.