Are benefits from key person insurance tax free?

Key person insurance benefits are indeed not subject to taxation, making this a fundamental aspect of how such policies function. When a business takes out key person insurance on an employee critical to its operations, any payouts received due to the death or disablement of that employee are typically considered tax-free. This tax-exempt status allows businesses to use the proceeds to cover lost income, recruitment costs, or other expenses without worrying about tax liabilities.

The rationale behind this is tied to the purpose of the insurance, which is to protect the business from financial losses tied to the key individual's absence. This financial security is crucial for maintaining business viability and continuity.

In contrast, other options touch on scenarios that do not accurately reflect the nature of key person insurance benefits. For example, the idea that they are taxed as income or at a higher rate misrepresents how these proceeds are treated under tax law. Additionally, while the tax treatment of premiums is relevant in different contexts, it doesn’t apply to the proceeds in the same way, further clarifying why the tax-exempt nature of key person insurance payouts stands as the correct understanding.