129 / If a debtor pays premiums on a life insurance policy on his or her life in favor of his or her creditor, may the debtor take an income tax deduction for these premium payments?
No.
The answer is the same regardless of whether the debtor takes out a new policy for the benefit of the creditor or assigns an existing policy to the creditor. The deduction will be denied even though the debtor was required to take out the policy to obtain the loan. If the debt is personal, the premiums are nondeductible personal expenses.1 If the debt is a business debt, the deduction is denied under IRC Section 264(a)(1), which provides that no deduction is allowed for premiums on any life insurance policy, endowment, or annuity contract if the taxpayer is directly or indirectly a beneficiary under the policy or contract. For this purpose, the insured debtor is at least indirectly a beneficiary under the policy because the proceeds may be used to satisfy the insured’s debt.2
IRC Section 264(a)(1) also acts as a bar to a nonbusiness deduction. Thus, the deduction was denied for premiums the taxpayer paid on insurance used as collateral for a bank loan to a company in which the taxpayer was a major stockholder; the premiums were paid to protect the taxpayer’s personal securities, which were also part of the collateral for the loan.3