Taxation of Life Insurance Proceeds Received By A Private Corporation, Partnership or Individual

Taxation of Life Insurance Proceeds Received By A Private Corporation, Partnership or Individual

Many small business corporations including farm corporations use life insurance as a way to protect assets says Grant Diamond, a senior tax consultant with FBC, a tax advisory service with over 60 years of service to the farm community. Premiums for permanent insurance on the principals of an organization are not deductible; however, the proceeds are also not taxable.  

In the case of a private corporation receiving a payout of a policy on the death of an insured shareholder, the net proceeds are taken into the capital dividend account of the corporation. Net proceeds are the payout less the adjusted cost base of the policy.

The capital dividend account is a mechanism that allows the corporation to move funds tax-free to Canadian resident shareholders by way of a special dividend. So, if the corporation elects to pay shareholders a dividend from the account, these dividends to shareholders resident in Canada are not considered as income and therefore not taxable.

Non-resident shareholders are subject to a 25% tax on dividends paid from the capital dividend account, therefore it is better to pay out taxable dividends to non-residents and save the non-taxable dividends for residents of Canada. Your tax practitioner can advise you accordingly.

If the net proceeds of a life insurance policy are received by a partnership, then this will result in a change to the adjusted cost base of each partner’s interest in the partnership. This has the effect of a partner receiving a non-taxable dividend and putting the taxpayer in the same situation as if they received the dividend personally.

How does this compare with the disposition of a life insurance policy to an individual? If the disposition or termination of the policy resulted from the death of the policy holder, the proceeds will not be taxable to either the estate of the deceased or to a beneficiary.

By designating a life insurance beneficiary of a protected class, savings in probate taxes or protection from creditors can be achieved by specifying that the proceeds will not be part of the estate.

If the disposition or winding up of a life insurance policy is initiated by the policy owner, the excess of the cash surrender value over the adjusted cost base will be treated as taxable income in the hands of the policy owner.

Some permanent insurance policies permit the ability to withdraw policy loans against the build-up of cash value in the policy. Policy loans up to the adjusted cost basis can be made without any tax implications.

Generally, insurance should be purchased for the death benefit to cover any risk associated with the loss of the insured. Any investment in the savings portion of a life insurance policy should be compared to other investments you might make.

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