The U.S. Income Tax Code is complex and confusing. In most cases, the income that you earn is taxed according to your total annual earnings. In theory, the country’s tax laws are set up to favor workers with relatively low incomes over workers with relatively high incomes. Depending upon your annual earnings, your income will be taxed at one of several “marginal rates” each year. These rates can be changed by Congress and fluctuate on an occasional basis. Current tax rates for the top category of wage-earners are about 40 percent of total taxable income. For earners in the bottom bracket, this figure is about 10 percent.
Certain types of “unearned income” are not considered taxable. When you receive unearned income, you must claim it as part of your gross income on your tax return. However, it won’t factor into the final calculation of your taxable income. In effect, the total amount of your unearned income will function as a deduction that may be applied to your gross income. Like a regular tax deduction, it will shrink the portion of your income that the federal government considers to be taxable.
“Unearned income” may include unemployment benefits and court settlements. In most cases, life insurance proceeds also fall into this category of income. You generally don’t need to claim the income that you receive from a life insurance policy on which you’re named as a beneficiary.
There is a notable exception to this general rule. A portion of the benefits that you receive through an employer-sponsored life insurance plan may be taxable under federal law. If you receive benefits from an employer-sponsored policy, you’ll be able to claim at least $50,000 of these as unearned income. Beyond that amount, you’ll have to pay taxes on any benefits that you receive. For instance, you’ll need to pay taxes on 87.5 percent of the proceeds that you receive from an employer-sponsored plan that carries a death benefit of $500,000.
Before you assume that your life insurance benefits are not taxable, consult with your tax attorney or a tax preparation specialist. You should also check with your state’s revenue service. In certain areas of the country, there may be state-level exceptions to the “unearned income” rule that governs life insurance proceeds. For instance, your earnings may be subject to your state’s estate or inheritance taxes. The rates on these types of taxes can be quite high.
Is there Any Way That I Can Write Off My Life Insurance Payments on My Taxes?
If you’re like most life insurance policyholders, you’re committed to ensuring that your family remains comfortable and solvent after your death. Whether your life insurance policy is structured as a temporary “term” plan or a permanent “whole” plan, chances are good that you’ve purchased enough coverage to support your family for many years to come. Unfortunately, your premium payments might be acting as a drag on your short-term budget. Depending upon the size of your policy, your life insurance payments could add up to several hundred dollars per month. In order to reduce this burden, you might be thinking about claiming these payments as a tax deduction or business write-off.
According to the IRS, private taxpayers and business owners are not permitted to claim their life insurance premiums as a tax deduction. This is due to the fact that life insurance benefits generally aren’t subject to regular taxation. Since the vast majority of life insurance beneficiaries aren’t required to pay taxes on the benefits that they receive, it would be redundant for the IRS to provide policyholders with a tax break. In effect, life insurance policies function like Roth IRA plans: Whereas their premium contributions can’t be subtracted from the policyholder’s taxable income, their benefits accrue on a tax-free basis.
There are certain situations in which life insurance benefits may be taxable. For instance, a business that purchases an individual’s life insurance policy for investment purposes might be required to pay taxes on its eventual proceeds. In this special circumstance, the business’s principal might be able to claim the policy’s ongoing premiums as a business expense. If the policy results in a payout, its proceeds would remain taxable at regular capital gains rates. If the policy expires without issuing a payout, the principal might be required to pay back the entire taxable value of the deducted premiums. This is a rare, complicated tax situation. If you find yourself grappling with such a scenario, you should talk to a licensed tax professional to determine your exact tax liability.
For private taxpayers, the benefits that accrue on unusually large employer-sponsored group term life insurance plans may also be taxable. If you hold such a policy, you may have to pay taxes on some of the contributions that you make on it. Likewise, the policy’s beneficiary will have to pay taxes on any death benefits that exceed the IRS’s $50,000 payout limit. If your policy pays out a benefit of $150,000, your beneficiary will have a tax liability of $100,000.