Tax Planning Through Corporate Owned Life Insurance

Corporate owned life insurance policy as the name suggest, is a policy owned by the corporation. Corporate owned life insurance policy is a measure of tax planning mostly by the private family owned corporation.

Normally, under a life insurance policy there could be three different people/entity. The first one is the owner of the Life insurance policy who owns the policy. Second one is the life insured whose life is insured under a policy and third one is the beneficiary of the policy nominated. Beneficiary is the one who is designated to receive the proceeds upon death of the life insured.

Treatment of Life Insurance Policy Premiums Paid:

Life insurance premiums paid by life insured or the corporation for that matter is not tax deductible except under the following three circumstances:

1)      When the life insurance policy is placed as a collateral.

2)      When the Life insurance policy is donated to the Registered Charity.

3)      When the Life insurance premiums paid are under a registered plan.

However, there is a wonderful tax planning available through corporate owned life policy as under:

What is involved?

Private Corporation can take out the life insurance policy on the life of the owner-shareholder or the key person of the company and the beneficiary nominated should be the corporation. This is because if the corporation is not designated to be the beneficiary of the policy, but instead the beneficiary is the family member of the owner of the corporation, it will be treated as the taxable benefit to the shareholder and taxed accordingly in the hands of the owner-shareholder. When the beneficiary is the corporation, it does not give rise to any benefit in the hands of the owner-shareholder. However, the premiums paid by the corporation is not tax deductible.

Although the premiums paid by the corporation are not tax deductible, it has a tax advantage compared to individual shareholder paying the premiums in his individual capacity.

Let us take an example, if the corporation is paying every month, $100 per month on the life policy of its owner-shareholder, the total pre-taxed annual cost of the insurance premiums will be $100 X 12=$1,200/0.85=$1,411.76, considering 15% tax rate for the small business corporation on its first $500,000 of taxable income. However, if the same premiums are paid by the owner-shareholder in his individual capacity, then the pre-taxed cost of the premiums will be much higher depending upon the marginal tax bracket of the owner-shareholder. Assuming that the tax rate for owner-shareholder is 40%, the effective cost of the premiums on the pre-taxed basis will be $100 X 12=$1200/0.60=$2,000.

As you observe it could be more beneficial to take out the insurance policy through privately owned corporation.

Death Benefits- its Tax Treatment and Capital Dividend Account:

As regards the payment of proceeds of the life insurance policy upon death is absolutely tax free, which is considered a great advantage.

Now the death benefits paid will be paid out to the corporation upon the death of the owner-shareholder and it will be tax free.

The death benefit paid out to the corporation minus the Adjusted Cost Base (ACB) under the tax rules forms part of a Capital Dividend Account from where the money can be distributed tax-free to its shareholder.

This way, the ultimately the proceeds payable upon the death can be drawn tax free by the family members of the owner of the corporation and effective cost of the premiums paid could be much lower without creating any tax disadvantage to its shareholder.

Disclaimer: Any discussion on this blog relating to tax matters is purely for educational purposes and not taking any specific actions based the general tax rules described therein. Your tax situation could be different and as a result there may be different tax strategies applicable in your case. We do not claim the tax situations described above to be exhaustive or conclusive. In case of any specific tax situations or problems, you are advised to seek professional advice.