Transcript No Slide Title

Demystifying
Corporate Owned
Life Insurance
Kevin Wark, LLB, CFP
CIFPS Annual
National Conference
Many insurance advisors shy away from
working with business owners due to
concerns about planning complexities…
However, a high level understanding of the
planning points around corporate owned
insurance will put you in the driver’s seat
1. Exempt Test Rules
Exempt Policies:
Qualify for tax deferred growth on cash
values
 Tax-free death benefit
 Disposition of policy may give rise to tax if
if policy’s cash value exceeds its adjusted
cost basis (“ACB”)
Rules for corporate owned policies similar to
individually-owned policies
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1. Exempt Test Rules
ACB Calculation
 Determined in same way as for
individual policyholders
 Increased by premiums paid and
certain other amounts
 Decreased by “proceeds of
disposition” and the net cost of pure
insurance (“NCPI”)
1. Exempt Test Rules
Dispositions Include:
 Surrender of policy (including
partial surrender or cash
withdrawals)
 Policy loan after March 1978
 Maturity of policy (e.g. endowment)
 Policy dividends
 Gift or non-arm’s length transfer
1. Exempt Test Rules
Planning Tips:
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Can reduce current income in a private
corporation through investing in an
exempt policy
Policy gains can be converted to tax-free
death benefit and distributed tax-free to
shareholders via capital dividend account
Leveraging concepts allow cash values to
be accessed on tax-free basis
2. Deductibility of Premiums
Insurance premiums are generally not
deductible by a corporation.
Exceptions:
 Collateral insurance
 Charitable gifting
 Employee benefits
 RCAs
2. Deductibility of Premiums
Planning Tip:
Have premium paid by corporation if in
lower tax bracket
Example:
Assume premium of $1000, corporation in
20% tax bracket and shareholder in 50%
tax bracket. Corporation has to earn
$1250 before tax to pay premium.
Shareholder has to earn $2000 before
tax to pay same premium.
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3. Capital Dividend Account
Capital Dividend Account (CDA)
 Notional tax account for private
corporations
 Represents amounts that would be
tax-free if received directly by
shareholder
 Difference between insurance death
benefit and ACB of policy included in
CDA
3. Capital Dividend Account
ACB reduced by NCPI
 Actuarial calculation of the cost of
insurance under the policy
 Generally equal to the “Net Amount
at Risk” (death benefit less the
cash surrender value of the policy)
multiplied by a mortality charge
specified in the ITA
3. Capital Dividend Account
Planning Tips:
 Clear out CDA on regular basis to
reduce value of company and
potential capital gains
 Split dollar with company owning
risk component of the policy
 Holdco owns policy with Opco as
beneficiary
4. Creditor Protection
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A corporate owned policy is subject
to claims of corporate creditors
If spouse of life insured is named as
beneficiary may be able to claim
creditor protection but will have
shareholder benefit issues
Same benefit issue if a shareholder is
named as an irrevocable beneficiary
4. Creditor Protection
Planning Tips:
 Split dollar/split beneficiary
insurance
 Holdco owns and is beneficiary of
the policy
 Collateral Insurance (Term)
5. Buy-Sell Agreements
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Death is a triggering event under
most buy-sell agreements
Life insurance usually most cost
effective method of funding
obligation to purchase shares
Need to work closely with lawyer
to ensure life insurance lines up
with terms of agreement
5. Buy-Sell Funding
Corporate Owned - Share
Redemption
 Corporation owns insurance on
each shareholder’s life
 On death the corporation redeems
shares of deceased shareholder
5. Buy-Sell Funding
Pre-stop loss rules:
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Capital gain realized by shareholder in
year of death could be offset by
capital loss realized in estate
Corporate owned insurance used to
redeem shares of deceased from
estate
Loss realized by estate when shares
are redeemed by corporation
Estate receives tax-free capital
dividend from corporation
5. Buy-Sell Funding
Pre-Stop Loss Rules - Example
 Joan owns shares worth $1 million,
ACB=0
 Opco owns $1 million life insurance
 On Joan’s death, estate files terminal
return with $1 million capital gain
 Redemption of shares creates
$1 million deemed dividend,
tax-free from CDA
5. Buy-Sell Funding
Pre Stop Loss Rules - Example
 Joan’s estate realizes a capital loss
of $1 million on share redemption
 Capital loss can be carried back to
final tax return to offset $1 million
capital gain
 Joan and estate pay no tax, but
surviving shareholders have future
$1 million gain
5. Buy-Sell Funding
Post stop loss rules:
Loss reduced in amount by which
capital dividend exceeds 50% of
lesser of:
(i) capital gain realized on death; and
(ii) capital loss realized in estate
 Rule means that 50% of redemption
proceeds can still be paid as a tax- free
capital dividend
 BUT double taxation can result if if not
properly structured
5. Buy-Sell Funding
Grandfathered Arrangements:
 Redemption agreement in writing before
April 27, 1995
 Acquisition of new or updated life
insurance coverage to fund agreement
will not affect access to grandfathering
 Changes to grandfathered agreements
may cause loss of preferential status
even if changes do not affect buy-sell
provision on shareholders death
5. Buy-Sell Funding
Grandfathered Arrangements:
 Also available for insurance policies
inforce on April 26, 1995; where
 A main purpose of the insurance was to
redeem shares held by a deceased
shareholder
5. Buy-Sell Funding
Planning Tips:
 Look for “grandfathered” situations
 Transfer shares to surviving spouse and
then redeem shares using insurance
proceeds
 Structure as share redemption but only
use 50% of CDA (hybrid agreement)
 Simplify matters by using corporate
owned promissory note method
6. Valuation of Corporate
Owned Policy
While Policyholder is Living:
 Generally valued at “fair market value”
 Look to a number of factors including
policy’s csv, health of life insured, cost of
a new policy etc. (IC-89-3)
 On disposition of policy its value = CSV
of policy
6. Valuation of Corporate
Owned Insurance
On Policyholders Death (IT-416R3):
 Policy on deceased’s life or other
non-arm’s length persons valued at
its CSV immediately before death
(i.e. ignore death benefit)
 Policies on “arm’s length” lives
valued at “fair market value” which
could take into account part or all of
the death benefit
7. Capital Gains Exemption and
Corporate Owned Insurance
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Can shelter up to $500,000 of
capital gains on disposition of
shares in a CCPC
90% or more of corporation’s
assets have to be used in an
“active” business
Insurance cash values not
considered to be part of active
business assets
7. Capital Gains Exemption and
Corporate Owned Insurance
Planning Tips:
 Keep cash values low in relation to
other assets in the corporation
 Use split dollar to hold cash values
outside the company
 Use a holding company to own the
policy
7. Reasonable Expectation of
Profit Test (REOP)
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Taxpayer can only claim a loss from
business or property where it is
reasonable to assume there will be
a cumulative profit
“Profit” does not include capital
gains
Annual test
Rules to be effective after 2004
7. REOP Test
Could impact a number of planning
ideas using leveraging to acquire
corporate owned insurance:
 Corporate back to backs
 10/8 insurance programs
 Corporate insured retirement
programs
7. REOP Test
Planning Tips:
 Better to borrow to invest in a
business rather than other types of
investments
 Make sure client has other sources
of income to utilize deductions
 Work closely with client’s tax and
accounting advisors
8. Sale of Business
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Corporation owns $1 million UL
policy with CSV of $100,000 and
ACB of $40,000
Assume shareholder wants to sell
all shares in corporation
Shareholder wants to retain
ownership of the policy
8. Sale of Business and Transfer
of Insurance Policy
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Transfer of policy to shareholder
will be a disposition - taxable gain
to corporation of $60,000
Shareholder will be in receipt of a
taxable benefit – at least $100,000
and possibly a higher amount if not
in good health
8. Sale of Business and Transfer
of Insurance Policy
Planning Tips:
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Ideally set up ownership of policy in
holding company from beginning
Establish holding company and distribute
policy as tax-free dividend
Use policy to repay any outstanding
shareholder loans
Transfer out as employee benefit so
corporation can deduct the payment
Corporate Owned Insurance
It’s as easy as learning your ABCs…
ACB =
CDA =
CSV =
FMV =
NCPI =
RCA =
REOP =
Discussion…