How are insurance payments treated differently, and how can this affect your bottom line as an employer? Here are the two basic categories of differences you will encounter as an employer.

Category 1: How to Handle Prepayments

Many types of insurance policies have at least some form of prepayment. You may put an amount down in advance and pay off another amount over time. You may also be encouraged to pay the premiums for three, six, or twelve months in advance in order to receive a discount or avoid other fees. 

Although prepaid insurance can help your business save money and time, it also has a complicated effect on the books. A company that uses the 'cash method' of accounting generally records income and expenses when they actually happen. So prepaying a standard $50,000 annual life insurance policy for employees may be recorded in its totality on the company books when you write the check. 

Companies who use the 'accrual method' of accounting, on the other hand, would record this expense in appropriate amounts throughout the coverage period. Usually, this is done by dividing the prepaid premium by the number of months of coverage and posting an equal amount to the books each month.

To further complicate matters, though, how prepaid amounts are handled under each of these accounting methods is not necessarily the same way you will treat it on tax returns. Prepaid insurance for an accrual-based company often cannot be deducted over more than a one- or two-year period for tax purposes. And a cash-based business taxpayer may still need to accrue that life insurance payment.

Category 2: Deductible and Non-Deductible Insurance

The other tricky part of deducting insurance expense is understanding which types of polices may be used to reduce taxes. Most employers wouldn't be surprised to know that their portion of health insurance payments are generally deductible. But would you be be surprised to know that an accident policy covering a working partner may also be deductible whereas loss of earnings coverage may not be?

Many specific types of insurance that are deductible on the company's (or the self-employed person's) tax returns are further subject to certain limits. Life insurance for key staff, for instance, is only deductible if the beneficiary is not the company. And self-employed health insurance may be deductible on Form 1040, but only up to the income earned from the business.

You may not even want to deduct every available type of insurance premium just because you can. If you deduct disability insurance premiums, any benefits received from using that insurance may be taxable income. The potential addition to an employer or employee's taxable income could be a higher risk than the moderate benefit gained by deducting premiums.

Because these expenses are reported differently on the books and on tax forms, your profit or loss may be significantly different than its profit or loss on income tax returns. So the only way to know your true profit margin is to understand how each expense will be handled in both sets of income calculations. This also allows you to do tax and budget planning by determining the necessity and effects of the insurance.

Clearly, the relatively simple act of taking out an insurance policy to aid employees or protect the employer is actually a much more complex subject. Your best source of advice and assistance keeping things straight is a qualified accountant.

At Bliss & Skeen CPAs, our experienced accounting team can help. Call today to discuss your specific insurance policies and their effects on your company's finances.