The ATO rules: Everything you should know about income protection insurance and tax

There is no tax deduction for most types of life insurance in Australia. This is because ATO guidelines state that insurance premiums aren’t tax deductible if a benefit under the policy is paid for physical injury. However, there are some exceptions, such as income protection insurance.

The expenses you incur directly related to earning income may be tax deductible. Income protection insurance premiums may be included, depending on the benefits covered by the policy, for example, insurance premiums for income protections and injury. Say that Stephanie takes out income protection and personal injury policy through her insurer. She pays a total of $500 a month for the policy. $325 of the premium Stephanie pays is for income protection cover, and $175 is for the personal injury cover. Stephanie can claim $325 a month for the insurance policy. The remaining $175 is not deductible because it is capital in nature.

In contrast, if you take out a policy through your superannuation fund and the premiums are deducted from your contributions or pay you a capital sum to compensate you for an injury, you can’t claim a deduction. This is because the insurance is paid from your superannuation rather than your income. Also, one of the most important factors (especially for self-employed individuals) seems to be the ability to earn assessable income. As a result, taking out disability insurance against income loss can generate a tax deduction for the premiums. For small business owners, protecting their ability to earn an income could also involve deductible insurance premiums to cover fire and theft, motor vehicles, public liability, and loss of profit.

Taxpayers should always seek specific advice regarding their specific situation, but there have been deductions allowed for the above insurance products, even when the coverage may include some capital assets – that is, the value of the item (such as a vehicle vital to the day-to-day running of a business) and its income-earning component.

When it comes to income protection coverage, it is often combined with disability or death insurance. Similarly, there is also a category of “capital” that is covered, which refers to the value that is allowed for the death of an individual or their injury or disabling condition, whichever is the case.

In terms of tax deductions, the income protection component of the premium is only allowable, which your insurance company should be able to explain. The ATO has been known to disallow a claim on premiums if it cannot show the components of a cover’s “income” and “capital” sides. Remember, you must include the payout in that year’s tax return when you claim such insurance.

It may seem straightforward for a business to deduct premiums for a key person or employee insurance, but this may not always be true. The loss of a key employee, even if they are temporarily out of action, can be financially devastating to a business.