How are premiums and benefits of a business overhead expense (BOE) disability policy treated for federal tax purposes?

Why A is correct

Because a BOE policy protects the business itself by paying its fixed operating expenses, the premiums are deductible as an ordinary and necessary business expense under federal tax law. Correspondingly, the benefits the business receives are taxable as ordinary income, since the premium deduction created the tax benefit. This mirrors the general rule that the tax treatment of disability benefits follows the tax treatment of the premiums: deductible premiums produce taxable benefits, while after-tax premiums produce tax-free benefits. The business should therefore expect to report BOE benefits as income on its return.

Why the other options are wrong

• B) Because the premiums are deducted as a business expense, the benefits must be reported as ordinary income. The deduction and the taxability of benefits are paired under the general premium-source rule.
• C) BOE premiums are deductible as an ordinary and necessary business expense because the policy protects the business. Because the premium is deducted, the corresponding benefits are taxable rather than tax-free.
• D) The premiums are deductible for a BOE policy, so the pattern in this option is reversed. Deductible premiums produce taxable benefits, while premiums paid with after-tax dollars produce tax-free benefits.

Memory hook

Deduct the premium, pay tax on the benefit — BOE is a business deal.