New York State Tax

Life Insurance Dividends and Tax

A permanent, participating life insurance policy is one that allows the policyholder to share in the profits of the company for the rest of his life. This profit sharing occurs through the payout of dividends. However, there's usually no guarantee that a dividend will be paid; it typically only occurs when the company's profit exceeds expectations.

Life insurance companies issue policy dividends in a variety of ways, and the insured can usually choose how he wants to receive the payment. He can request a check in the mail or ask the company to use the money to lower the cost of his premiums. In addition, he may be able to use the money to purchase additional single-premium policies that also pay dividends, or he can have the funds credited to his account where they will accumulate interest.

Companies pay life insurance policy dividends on the policy anniversary date, one year after it accrued. The Internal Revenue Service (IRS) doesn't consider dividends as personal income until the value of the dividend exceeds the net premiums paid on the policy. At that point, the insured reports the dividends as income on his federal tax return.

The situation, however, is a little different if a company pays the life insurance premiums and reports this as a tax-deductible business expense. In this case, the dividend acts like a rebate, and the business should deduct the amount of the dividend from the reported cost of the premium. If the company doesn't do this, the IRS considers the dividend as taxable business income.

The interest earned on life insurance dividends is taxable if you've received it, or it's in an accessible policyholder's life insurance account. If you can withdraw the money, it's taxable in the year it accumulates unless there are withdrawal restrictions on the account. For example, the policy may specify that the policyholder may only withdraw interest on the policy's anniversary date. If that's the case, you report the interest in the anniversary year and not the year it was credited to your account.

U.S. armed forces veterans and their beneficiaries are exempt from paying taxes on life insurance policy dividends and dividend interest.

If you need help filing your income tax return or have other questions regarding life insurance and tax, you can use these links to find professional Certified Public Accountants in your area.