Understanding how umbrella insurance actually works as a secondary safety net if a primary insurance policy is not enough, it’s rare for an umbrella coverage to actually be used in Columbia, MO. However, it does happen, and either a policy holder or a party whose damage is addressed can both be in the situation of actually receiving a benefit. When this happens, the issue of tax exposure comes up.
Generally, the Internal Revenue Service, better known to folks as the IRS, treats insurance benefits as non-taxable. That’s because the primary nature of an insurance benefit is to restore a person for their loss versus make a profit. However, not every insurance benefit is exempt. For example, damage to a primary home that exceeds an original homeowner’s insurance plan and then gets covered by an umbrella plan is not taxable. Both meet the definition of restoration for a loss, per Walker-Winter Insurance. However, where the property is an investment second home, things start to get a bit murky. In another example, a party sues for damages due to a slip and fall that includes both medical cost damages as well as pain and suffering and punitive damages. The homeowner’s umbrella insurance plan then provides a settlement for all three. The portion beyond medical expenses and dealing with the ambiguity of mental suffering could be taxable.
Where the policyholder is the one receiving the insurance benefit for losses covered, generally these are not taxable as the recovery is replacing an expense the policyholder has suffered. The financial math is considered a wash by the IRS versus a gain, which would otherwise make the payment taxable from what Walker-Winter Insurance has seen. And keep in mind too that just because the IRS doesn’t consider a benefit taxable, it doesn’t mean a given state agrees. State laws for Columbia, MO can vary a bit from Federal tax law.