Why sell your existing personally owned policy to your company? A benefit is it takes less pre-tax income to pay the premiums, which lowers the cost. Based on current tax rules a second benefit gives the ability to withdraw funds equal to the fair value of the policy from the company on a non-taxable basis. Let’s look at the tax consequences of transferring a personally owned policy (individual shareholder) to his/her corporation.
In the past columns, I have talked about the section in the Income Tax Act that refers to Life Insurance it is 148. In section 148 there are several subsections, one of them talks about transfers between parties who are not arm’s length. The Act, says the shareholder has a disposition of the policy, because the transfer is between parties who are not at arm’s length.
Therefore, it deems both the proceeds of disposition to the shareholder and the adjusted cost base (ACB) to the corporation to equal the cash surrender value (CSV) of the policy.
The corporation will pay an amount equal to the CSV to the shareholder as consideration for the policy. Since the shareholder’s proceeds would be equal to the CSV and has given the corporation the policy as consideration, there is no taxable shareholder benefit. This allows the corporation to distribute an amount equal to the CSV of the policy to the shareholder without incurring any further tax.
Now here’s the interesting part if the shareholder can substantiate that the policy has a fair market value (FMV) higher than the CSV, and then the shareholder may be able to receive consideration from the corporation greater than the CSV of the policy without attracting additional taxation in the hands of the shareholder.
No shareholder benefit should result as long as the consideration paid does not exceed the fair market value of the policy. Therefore, the shareholder has essentially extracted the difference between the FMV of the policy and the CSV on a tax-free basis. The corporation’s new ABC of the policy would remain equal to the CSV and not the higher FMV. The lower ABC, could be an advantage in that the credit to the capital dividend account (CDA) upon death of the life insured would be greater; as the CDA credit is equal to the death benefit proceeds minus the ACB of the policy. As you can see, this may be an attractive strategy for pulling out funds from a corporation.
The following are some longer-term matters that may come up: A corporate-owned policy can be exposed to the creditors of the corporation; A corporation will generally be the beneficiary of the policy; given this, consider whether there is an appropriate and tax-efficient method to get the death benefit to the intended beneficiary; If the company is sold in the future to a third party there will be a tax bill to move the policy out.
POLICY OWNERSHIP
Personally Owned or Corporately Owned that is the question… and of course it depends on why you are buying the policy in the first place. The remainder of this column will be based on a concept that helps protect the financial well-being of your family and can also help you achieve the retirement lifestyle you deserve. Each insurance company tends to name concepts differently but they all do the same thing.
Corporate Insured Retirement Program – Most people think of permanent life insurance as money paid when someone dies. They know it’s a great solution for paying a tax liability at death, providing an estate for loved ones or leaving a gift to a charity. But what about planning for retirement? Without careful planning, you may not have enough savings when you retire to maintain the standard of living you’re enjoying now. With this financial planning strategy, your corporation deposits funds into a permanent life insurance policy in excess of the amount required to cover the insurance and other policy costs. In the future, your corporation assigns the policy to a bank as collateral for a loan to you.
By having your corporation purchase the life insurance policy and use it in this manner, you address your needs for permanent life insurance protection today and flexibility at retirement. You must use permanent cash value life insurance policies, such as whole life and universal life. They are the instrument that forms the program; with their tax-free death benefit and the tax-preferred cash accumulation benefits they offer. Permanent life insurance plans that build cash value can provide short-and long-term planning opportunities for your corporation too.
This strategy provides the corporation with valuable life insurance protection on a key-person or shareholder and the opportunity to access policy values tax-free immediately or in the future. Expectation – Darrin wants the flexibility to access corporate investment assets in a tax-effective manner while reducing the tax bite on these assets.
Darrin wants a solution that provides flexibility. The corporations’ income has been stable for several years. Darrin also wants to start building a more aggressive balanced asset mix while reducing his taxes on his corporations’ invested surplus. He understands that if business increases at a minimum he expects the corporation will owe sizable capital gains taxes on his death. He wants to ensure the value of the corporation is protected for his children and grandchildren. My Solution to Darrin was the Corporate Insured Retirement Program with corporate borrowing. I explained to Darrin there are many reasons business owners purchase permanent life insurance: key-person protection, funding buy-sell agreements or maximizing corporate assets for their heirs. Permanent life insurance also provides cash accumulation opportunities on a tax-preferred basis. The corporate Insured retirement program demonstrates how a corporation can have valuable life insurance protection and the opportunity to access policy values tax-free immediately or far-off in the future.
The mechanics: A corporation is the owner, beneficiary and pays premiums for a tax-exempt life insurance policy on the life of a shareholder (Darrin). When the policy has accumulated cash values, the corporation can pledge it as collateral in exchange for a series of tax-free loans from a third party lender. The corporation can then pay a taxable dividend to Darrin. If the corporation uses the loan proceeds directly to earn income from a business or property, the loan interest may be tax deductible. At death, the tax-free death benefit first pays the outstanding loan plus accumulated interest. The corporation may post the entire death benefit to its capital dividend account (CDA), minus an amount equal to the policy’s adjusted cost basis (ACB). An amount equal to the CDA can be paid to the shareholder’s estate as a tax-free capital dividend. Any amount remaining can be paid as a taxable dividend.
What we did for Darrin’s corporation was purchase a $1,000,000 Universal Life insurance policy with a 15 year pay period and used $50,000 of the company’s corporate surplus. Over the life of the policy it would help reduce the corporation’s taxes payable on their investment income. Darrin can use the after-tax dividend income of $30,000 from the corporation to supplement his retirement income at age 65 for 15 years. Darrin’s estate receives $2,076,242 after the loan balance is repaid. This is an advantage of $859,065 over the net estate value provided by the alternate investment. This is for illustrative purposes only Based on (age 48 non/smoker) growth rate of 5.5%. Alternative investment rate 6%, loan rate 7.5% and Darrin’s marginal tax rate 45%.
The outcome for Darrin – Life insurance protection, a wide range of investment options to choose from that allows the corporation to build a portfolio as aggressive or conservative he would like; the more appealing was the fact that the corporate surplus can grow on a tax-preferred basis within the plan. At Darrin’s death the proceeds create a credit to the corporation’s CDA, helping to significantly increase the net estate value available for Darrin’s children and grandchildren.
Expectation – Brittany wants the flexibility to access corporate investment assets in a tax-effective manner while reducing the tax’s payable on these assets. Brittany wants a solution that will provide guarantees and stability while protecting the corporation’s corporate surplus; she knows that by investing only in interest bearing investments will not give her the growth and tax savings she needs on the corporation’s invested surplus. She expects the corporation to keep growing at the current rate and anticipates a sizable capital gains tax on her death. She wants to ensure the value of the corporation is protected for her children and grandchildren. My Solution: Brittany’s desire was very similar to Darrin’s so I used the same concept The Corporate Insured Retirement Program with corporate borrowing; although, we chose a different type of policy, a participating whole life. The mechanics: are the same as Darrin’s.
The outcome for Brittany: We determined that the corporation needed permanent life insurance and for Brittany using whole life insurance protection was the best way to go for a hands off investment strategy. A $1,000,000 participating whole life policy was issued with the extra premium benefit which provides additional tax-sheltered accumulation to the policy. We used a corporate surplus of $48,460 which is transferred to the policy each year for 15 years. Which helps reduce taxes the corporation pays on investment income. Brittany can use the after-tax dividend income of $35,000 from the corporation to supplement her retirement income at age 65 for 19 years. Brittany’s estate receives $3,274,319 after the loan balance is repaid. This is an advantage of $2,230,920 over the net estate value provided by the alternate investment. This is for illustrative purposes only Based on (age 44 non/smoker) participating whole life with paid-up additional insurance. Alternative investment rate 5%, loan rate 7.5% and Brittany’s marginal tax rate 45%.
The corporate surplus transferred to this plan can grow on a tax-preferred basis. Guaranteed cash values and policyholder dividends provide stable and consistent cash value growth. At Brittany’s death, proceeds create a credit to the corporation’s CDA, helping to significantly increase the net estate value available for her children and grandchildren. As an independent insurance broker, working primary in the corporate and professional market place we are very familiar with how to package the best products and know about all of the available coverage’s. I consider myself an educator and like to work with people that want to learn how they can