When your business suffers a loss, having insurance can make you whole again and get you back up and running. But a loss, whether it’s property damage, a lawsuit, or a cyber incident, can be time-consuming and often upsetting. The last thing you want to worry about is whether your business insurance claim payment will be taxed. But are the funds you receive from your business insurance claim taxable?
Here’s what you need to know.
Most Business Insurance Claim Payments Are Not Taxable
The purpose of insurance is to make the insured ‘whole’ after a loss, meaning they should be returned to the point they were at when the loss occurred, in terms of their assets. Obviously, if there is an accident that causes physical injury or disfigurement that cannot be corrected, they cannot technically be made ‘whole.’ In a case like this, the insurance settlement is intended to return the injured party to their previous quality of life as closely as possible.
This means that, if your 5-year-old printer is damaged or destroyed by water damage, your insurance company will pay for you to replace it with another 5-year-old printer. It will not pay you to replace it with a brand-new all-in-one copier-printer-scanner-rocket ship. (Of course, if you want a brand-new all-in-one copier-printer-scanner-rocket ship, you can buy one, but you’ll have to include some of your own money to make up the difference in value.)
Since your insurance claim proceeds are supposed to make you whole after a loss, they are usually not taxable. Presumably, you were already taxed on the money you spent to buy the item in the first place; if so, you would not be taxed on the money provided to replace the item.
In the same respect, if you use your insurance settlement to purchase an item for your business, you cannot deduct as a business expense any portion that was paid for using those reimbursed funds, as presumably you already claimed a deduction for that expense.
Here’s an example:
A photographer is shooting a wedding at a popular venue. They have set up their tripod near the cake table to get some good shots of the wedding couple as they cut their cake. The four-year-old ring bearer, who has had too much sugar already, runs across the room to get a good look, knocking over the tripod and the expensive camera that’s mounted on it, destroying the camera and the tripod.
The photographer’s business owner’s insurance policy pays them for a replacement of the camera and tripod, so the claim payment is not subject to tax.
Some Specific Types of Claim Payments May Be Taxed
There may be cases when an insurance payment is taxable. If the insurance claim covers a settlement or judgment that includes punitive damages, the punitive damages are taxable and should be reported as other income on your tax return. For example, if your business is sued and you are found to be liable for damages, including punitive damages, the amount of the claim that represents the punitive damages may be taxable to the plaintiff (the person suing your business in this example).
If an insurance claim includes payment for emotional distress, this amount may be taxable. Different states treat these kinds of payments differently, so it’s important to understand the laws in your state.
In the unlikely event that the amount paid by the insurance company exceeds the purchase price or value of the item being replaced, the amount above the item’s price or value on the business insurance claim could be taxable.
Beware of Possible Capital Gains Taxes
If you have unrealized capital gains on the item being replaced, it can get a little trickier. You may be liable for capital gains tax if you don’t replace the item within a certain period of time and it resulted in a gain. For example, suppose you own the building in which your business is located, and it is destroyed in a fire. If your adjusted basis (the original cost of the property and cost of improvements minus any depreciation) in a property is $250,000 but at the time of the fire, it was worth $400,000, the $150,000 difference could be considered a taxable gain. [SC1] If you got an insurance claim payment of $400,000 but you choose not to rebuild or wait too long you could be taxed on the gain. The same applies if you have an excess amount from the settlement compared to your basis. In this example, that excess amount would be the $150,000 difference between your adjusted basis in the building and what it was worth when it burned down.
If you have questions about whether all or part of an insurance claim payment is taxable, consult a tax expert to be sure. Our partnership with TurboTax can help you make the most of your income and expenses, plus help uncover business and industry-specific deductions. Even save 20% on your self-employment or business taxes with this special link.
Business Insurance Premiums Are Tax-Deductible
It’s worthwhile to note that the premiums you pay for your business insurance policies are generally a tax-deductible business expense as long as it is ordinary and necessary to your business. Be sure to report your monthly or annual premiums to your tax advisor when calculating your business expenses for your tax return.
Protecting your business with the right insurance is a smart decision. Learn more about the right coverage for your business at hiscox.com.
The preceding content is for general informational purposes only and is not intended to provide tax, legal or other professional advice. Individuals should consult with their professional advisors for advice on their tax obligations.