Key man life insurance premiums are generally not tax‑deductible for a partnership; they are treated as a non‑deductible expense unless the partnership owns the policy and is the beneficiary, in which case the premiums are capitalized and recovered as income when the death benefit is paid.
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Why premiums are usually non‑deductible
The IRS classifies life‑insurance premiums as a personal expense rather than a business expense. Because the benefit is intended to replace the loss of a partner's services, the cost is not considered an ordinary and necessary business expense under §162.
When premiums can be treated differently
If the partnership purchases the policy, is the owner, and names the partnership as the beneficiary, the premiums must be capitalized on the partnership's books. The capitalized cost is added to the partnership's basis and recovered as taxable income when the death benefit is received.
Tax reporting implications
The partnership reports the capitalized premiums on its tax return (Form 1065) as a non‑deductible expense. Upon the death of the insured partner, the death benefit is included in the partnership's income, offsetting the previously capitalized amount.
Comparison of treatment scenarios
| Ownership | Premium treatment | Tax outcome |
|---|---|---|
| Partner-owned policy (partner pays) | Non‑deductible personal expense | No deduction; no income to partnership |
| Partnership‑owned policy | Capitalized expense | Added to basis; taxable when benefit paid |
Key considerations for partnerships
- Document the business purpose of the policy.
- Ensure the partnership is the owner and beneficiary to apply capitalized treatment.
- Consult a tax professional to align the policy with partnership agreement provisions.