Life insurance is a staple in most private companies. To demonstrate how a firm should enter corporate-owned life insurance on its balance sheet, we’ll look at the following example.
Aco Corp. purchases a permanent insurance policy on the life of its shareholder, Ben. The death benefit is $1 million. Aco pays premiums and the cash surrender value of the policy increases. In year 25, Aco receives a $1 million death benefit when Ben dies.
Note: the accounting treatment of corporate-owned life insurance does not reflect the income tax treatment. The payment of life insurance premiums is generally not tax deductible.
So, while the annual insurance expense in each of years 1 through 14 is $10,000 and an accounting entry is made to reflect the payment, the expense is not deductible against Aco’s taxable income. An accountant makes this tax adjustment when preparing Aco’s tax returns.
The increase in the year-over-year cash surrender value is not taxable. Nor is the receipt of life insurance proceeds taxable income. Again, an accounting entry reflects receipt of the insurance proceeds.
When Aco’s financial statements are prepared, $750,000 will be removed from income for tax purposes. The other portion of the entry ($250,000) was simply eliminating the asset from the balance sheet.
So Aco receives $1 million in cash as the death benefit, which is reflected on its financial statements; however, there is no tax liability from receiving those proceeds when Ben passes.
Aco will also receive a credit to its capital dividend account when the life insurance proceeds are received. But, there is no accounting entry at that time and it is a tax-specific issue. The cash surrender value in an insurance policy represents an asset and needs to be correctly recorded on the financial statements. So consider accounting and taxation issues separately.