Insurance can be complicated but when you introduce tax implications related to corporate life insurance plans the complication factor rises enormously, says Grant Diamond, a senior tax consultant with FBC, a tax advisory service with over 60 years of service to the farm and rural small business community.
This article will cover the tax rules associated with the purchase of life insurance as a corporation or partnership.
Let’s start with the basic description of the 4 types of life insurance.
1. Group Term Life Insurance
Group term life insurance may be offered by a company or partnership for life and accidental death and dismemberment (AD&D) coverage. It may only be available to the employee or may also provide coverage to family members. As long as all full-time employees in the group have access to coverage, the insurance premiums are deductible to the employer.
2. Term Life Insurance
Term life insurance is life insurance that provides coverage at a fixed rate of payments for a limited period of time, also known as the relevant term. After that period expires, coverage at the previous rate of premiums is no longer guaranteed and the client must either forgo coverage or potentially obtain further coverage with different payments or conditions.
The above 2 insurance policies are also known as pure insurance.
3. Whole Life Insurance
Whole life or permanent insurance is a life insurance policy that remains in force for the insured's whole life and requires (in most cases) premiums to be paid every year into the policy.
4. Universal Life Insurance
Universal life is another form of permanent insurance that provides protection along with a tax-advantaged investment component. As cash values accumulate, they can be used to pay part or all of the cost of your insurance.
In addition to providing security and protection through its life insurance component, the cash value component of universal life insurance can be accessed for emergencies, retirement or for estate planning needs.
Whole life and universal life comprise pure insurance and tax-sheltered savings components and command higher premiums than term life insurance.
In the case of group term life insurance policies, premiums paid by the employer are a taxable benefit in the hands of the employee.
Other than providing a benefit to employees, corporations and partnerships will frequently acquire insurance to:
- Protect the business against the loss of an operating partner or key employee.
- Fund a buy/sell agreement to protect each co-owner on the death or disability of a stakeholder.
- Make sure the business can always pay the bills if it depends on an owner’s ability to generate income.
If a whole life insurance policy is used as collateral for a loan as required by a lender and the interest on the loan is deductible, the premiums related to the net cost of pure insurance (equivalent to the premiums associated with term life insurance) would also be deductible.
For example, on a $500,000 policy securing an average annual loan balance of $200,000, only two-fifths or 40% of the net cost of pure insurance is deductible. For tax purposes, the lesser of the above two amounts would be deductible.
The net proceeds from the policy on the death of the insured are added to the corporation’s capital dividend account. This amount can be distributed tax-free to the shareholders. Such a distribution to a partnership would increase the adjusted cost base of each partner’s interest.
Grant Diamond is a tax specialist with FBC, a firm dedicated to providing farmers and small business owners with expert tax services and advice for over 60 years. FBC has branches in BC, AB, SK, MB, ON and NS to serve its 50,000 Members. FBC also provides financial & estate planning. To learn more about FBC, visit www.fbc.ca. If you have any questions regarding this article, email fbc @ fbc.ca or call toll-free 1-800-265-1002.
Accurate as of April 08, 2015