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Are Insurance Claims Taxable?

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Are Insurance Claims Taxable?

If you have experienced severe damage to your home as a result of flooding, fire or wind, then you’ve probably gone through the process of filing an insurance claim with your insurance carrier.

If you are one of the many that has experienced this ordeal then you know that the whole process takes months & sometimes you don’t even get fully covered by your insurance carrier.

If you are one of the fortunate ones and your claim does get approved then the first question that usually comes up is, “Are the proceeds from the claim taxable & then what happens if I don’t use up all of the proceeds?

Is those unused proceeds considered income?”

Generally Proceeds are not Taxable

If the settlement was for damage to physical property of your home (and not punitive type damages); the proceeds are generally not considered taxable income that would needed to be reported as such on your income tax return.

Reporting the Insurance Settlement on Your Tax Return

The only situations where you would report the damage and/or proceeds on your tax return are under the following conditions:

1) You can claim a casualty loss on your Schedule A or your itemized deductions (which if you received a settlement from insurance, it is likely you will not meet all the criteria to claim any deduction).

If you do claim a casualty loss, the amount eligible for the loss is reduced by the proceeds received.

2) If you claim a casualty loss in one year and end up getting insurance proceeds in a later year, you then would need to report the reimbursement proceeds as income.

3) Lastly, if the proceeds received from insurance is greater than the basis or value of the property (which would be surprising), than the difference is a gain.

This gain is taxable on your return if you do not use the proceeds to purchase replacement property.

More than likely, none of the above applies.

If you had minor damage to your home which occurred in the same year you received the insurance settlement and you used the proceeds to fix your home, it would most likely not fit into any of the scenarios explained above.

Thus, it would not be taxable or reportable on your tax return. It is very advisable to understand the details of your specific situation as applicable to each of these insurance settlement scenarios that I’ve listed above.

Taxable Life Insurance Interest

Life insurance interest that can be withdrawn is considered taxable income and must be reported on your tax return.

However, life policy proceeds that you receive after the death of a love one cannot be touched by the IRS. Any interest that is paid and installment payments are considered taxable income.

Interest received from a insurance claim is treated as any other paid interest.

The IRS will tax this interest as they would interest from a bank account. In some cases a lump sum is due at the time of death to the beneficiary, that lump sum is tax free. If there is any interest added to the lump sum than only the interest is taxable.

For instance, if you receive 70,000 in insurance pay out and addition 500 interest, giving you a total of 70,500, the 500 is taxable.

If you were to receive only the 70,000 and nothing more than you do not have to report it on your income tax.

Installment payments must be reported to the IRS. Installment payments are life insurance benefits as well as interest combined into one.

The interest that is added on will be taxed and any benefit dividends will be excused. Financial institutions inform the IRS of any interest paid out.

So chances of you slipping through the cracks are unlikely. If the awarded interest is ten dollars or more you are required to complete a 1099-INT. Failure to report your interest will result in a penalty owed to the IRS.

Regulated and None Regulated Insurance

The difference between regulated and none regulated insurance in simple terms and in regard to Life insurance products.

Regulated:

A person organising this type of Insurance must be qualified (Diploma of Financial Planning) and meet educational and ongoing requirements set out through ASIC Regulatory guide 146. The adviser must work within the “know your client” legislation, this means the adviser must take into account your current situation and future plans and then advise you on the best type and amount of insurance to suit those needs. The adviser takes responsibility to make sure the insurance is appropriate and the levels are appropriate and the client can afford those premiums when the policy is taken out and through the life of the policy.

None Regulated commonly known as General Insurance:

The type regularly advertised on TV and Radio.

When you take out this type of Insurance you tell the person selling it to you how much you want, its then your responsibility to make sure the insurance is right for you.

The difference in the sales process of getting Insurance.

Regulated this is an advised sale. The client sits with an adviser, the adviser takes detailed information from the client, typically about the clients goals, family, children, lifestyle. Goals for now (immediate) plans for the next 5 years and long-term plans, 7 years and over, any health issues, these can be as serious as heart condition, cancer, diabetes down to past sports injuries. The adviser then takes the information away, will do a “GAP ANALYSIS” will then source the very best insurer to suit the clients needs to fit within the clients budget. This could even be with Super to make it more tax effective. These policies are “underwritten at the time you make the application” so when you make the application you fill in a medical questionnaire and more than likely the insurer will ask for a Doctors report, blood tests and in some cases a full medical. once the policy is in place the client is the only person who can cancel the policy. If a claim is made even for death for a pre-existing illness (other than suicide within the first 13 months) the insurer is guaranteed to pay.

None Regulated this is just a sale. The client calls a call center where the operator is trained on sales techniques, the operator will ask your date of birth smoker or none smoker and occupation. The operator will then tell you, you can have X amount of insurance for X amount per month. Its then up to you to read the Product Disclosure Statement to see if the insurance is suitable for you. These policies are “underwritten when you make a claim” so when you make a claim the insurer will ask for medical records in the case of death if death occurs from a pre-existing condition that was known of within 7 years of taking the policy out then this will be excluded and there will be no payout.

People find this attractive because its quick and they don’t ask any medical questions, although some do ask if you’ve had cancer or heart attack and if so they will not offer you the insurance, also your occupation can make you ineligible. But the big sell to the majority is cheap and no medicals.

Premiums

Premiums in Australia can be stepped or level. In almost all cases premiums for None Regulated Insurance are stepped. For Regulated insurance they can be either.

Stepped Premiums – Your premiums increase every year with your age.

Level premiums – Your premiums generally do not increase and are based on your age when you took out the policy.

Level premiums – Are generally higher at the start than stepped however as stepped premiums increase over the years level premiums become cheaper usually at the stage when your more likely to need the insurance.

So for younger clients its more cost effective to have level over the term of a policy this could save the client tens of thousands of dollars.

Tax deduction of Insurance policies.

For all types of policies Non and Regulated generally premiums for Income protection policies are tax deductible. However income from the insurance is taxable.

Insurance in Super

It can also be beneficial to hold insurance via superannuation.

Insurance held via super is owned by the Trustee of the Super fund for the benefit of the insured member. The Trustee deducts the insurance premiums from either ongoing contributions or the account balance of the fund.

In general Death, TPD and Income protection can be held in the Super environment (not trauma/ Critical Illness)

The premiums for death, TPD and Income Protection purchased through a Super are completely deducible to the fund. You can usually fund the insurance premiums via a tax-deductible Super contribution if you are self-employed, or out of your employer contributions made to your Super fund.

You can’t do this with None Regulated Insurance.

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