The pain of having to fork out for insurance premiums can be somewhat justified when the event you are insuring against comes to fruition — although it’s probably safe to say that in general terms most people would rather not have that satisfaction, especially with insurance such as life or disability. However, there can be some pre-emptive relief from the pain of these payments through taking account of the possible tax deductions available for premiums on certain forms of insurance cover.
General rules for claiming a deduction
As a general guideline, the ATO will allow a deduction for insurance premiums if it can be shown that the insurance relates to earning assessable income.
Income protection insurance is one example of the kind of cover that provides an allowable tax deduction for premiums, as is sickness and accident insurance cover.
The ATO states that “you can claim the cost of any premiums you pay for insurance against the loss of your income”, and that you “must include any payment you received under the policy for loss of your income … on your tax return”. Such payments must be declared for the financial year in which it is received.
The ATO notes however that you cannot claim a deduction for policies to compensate for such things as physical injury. Life insurance, trauma insurance and critical care insurance are other policies for which premiums are commonly not deductible.
The deciding factor centres on the insured event influencing a taxpayer’s ability to earn assessable income. For the self-employed, for example, this can mean that taking out disability insurance against loss of income could generate a tax deduction for the premiums paid.
For anyone running a small business, insurance premiums incurred in relation to protecting the business’s income earning capacity or protecting its business assets (eg. premises) would typically be deductible. Commonly deductible premiums include car insurance, building insurance or cover for professional or public liability.
Combined insurance covers
Some combined insurance products may cover both a loss of income and capital, which can create difficulties in working out the extent of any deductions for the premium paid. Income protection cover, for example, is often offered with combined death and disability cover. This means there is a form of “capital” that is covered – this being the value allowed for the death of a person, or that person’s injury or disablement. These are normally paid out in a lump sum.
In working out the the premium’s tax deductibility, it is only the income protection component that is allowable. Where the policy provides benefits that are capital in nature, premiums may have to be apportioned between the income and capital components. It is important to note that if the premiums cannot be apportioned, the ATO has been known to treat the whole of the premium as being non-deductible.
Insurance cover taken by business
For a business, premiums paid for workers compensation are tax deductible. Some businesses may pay premiums that cover for foreign exchange losses that may arise from obtaining loan funds overseas to be used in the business. A deduction is generally available for costs incurred in respect of such cover.
Another type of insurance product that is common for businesses is “key person” or “key employee” insurance. This is to cover situations where the loss of the key employee, even if temporarily out of action, can be financially damaging to the business.
While the deductibility of premiums for this type of cover may seem a given, this may not always be the case. Premiums for such cover will be deductible if the protection is for “revenue” – such as having the policy specify that cover is for loss of profit or business revenue due to the death or otherwise of the key person insured.
But if the policy is seen by the ATO to be taken out to protect from losses that are more of a “capital” nature (where for example, a lump sum is paid to the key person’s estate) then the premiums may not be allowed as deductions.
Where both types of cover are involved in the one policy, again some apportionment of premiums may be needed to work out the amount deductible. Some policies may not clearly define these items.
Where to from here?
To work out whether insurance premiums are deductible, it would be necessary to refer to the insurance contract, including any product disclosure statements from the provider. This will allow you to fully understand the type of cover sought and whether there are any “revenue” and/or “capital” components.
The simple message is: if you are considering various forms of insurance cover, consult with our office before committing to your policy or paying your premium.