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Don't count on deducting life insurance costs

Article

If you practice with partners, your buy-sell agreement is an important way to develop a plan to purchase an owner's interest under a variety of circumstances and to protect your own interest in those same circumstances-one of which is the death of a partner.

If you practice with partners, your buy-sell agreement is an important way to develop a plan to purchase an owner's interest under a variety of circumstances and to protect your own interest in those same circumstances—one of which is the death of a partner. (For more on death and your practice, see "The worst-case scenario survival handbook: Veterinary edition".) Life insurance, which provides the deceased's family an immediate source of cash to manage their affairs after losing a loved one, is a key part of most buy-sell agreements.

However, with tax time upon us, you need to be aware that life insurance in this situation isn't tax-deductible. In fact, it isn't deductible in either of the two types of buy-sell agreements listed below.

1. Cross-purchase agreement. With this common type of agreement, each owner purchases a life insurance policy on the other owners' lives. When there are three or more owners, it's usually more cost-efficient to set up a separate partnership to own the life insurance. This reduces the number of policies you need to purchase. Practices most often buy level-premium term policies for these arrangements. With this type of policy, the premium stays the same every year over the life of the policy. They can be purchased for 10-, 20-, or 30-year terms and are usually long enough to cover the length of the relationship.

Because the nature of the relationship for these agreements is personal, life insurance purchased to fund them isn't considered a business expense and is not deductible for income tax purposes. Often, the funds needed to cover the life insurance payments are paid to the owners as wages, and then the owners use the funds to pay the premiums. The owner who is paid the wages declares them as income on his or her personal tax return and reports them as a practice expense.

2. Corporate redemption. Under this type of agreement, the life insurance policies are owned by the corporation and the corporation funds the repurchase of the owners' shares. The corporation pays the premiums, but the payments aren't tax-deductible.

Of the two agreement types, cross-purchase agreements are more widely used since the purchaser of the deceased partner's interest gets a tax basis for the purchase and pays less tax upon the sale of his or her interest.

Review your agreements at least once every five years. If it's been awhile, now's a great time to call your attorney and conduct a thorough analysis.

Gary I. Glassman

Gary I. Glassman, CPA, is a partner with Burzenski and Co. PC in East Haven, Conn., and a Veterinary Economics Editorial Advisory Board member. Catch his talk, "Start-ups and Buy-ins: What You Should Know," April 17 at CVC East in Baltimore.

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