Corporate Life Insurance: Planning Tool or Tax Trap?

2 hours ago

3 min read

If you own a corporation, you have probably seen the ads: "tax-free corporate money," "zero-tax retirement income," "the CRA-approved strategy the banks don't want you to know about." Most of them involve corporate-owned life insurance.

Corporate-owned life insurance can be a useful planning tool. It has legitimate roles in insurance protection, succession, financing and estate planning. But it is not a guaranteed way to take money out of your corporation tax-free, and the strategies sold that way often leave out the parts that create tax.

Start by mapping every step

Before you rely on any illustration or sales pitch, make sure you can answer each of these questions in writing:

Who owns the policy, who pays the premiums, and who is the beneficiary?
Who borrows the money, and who actually receives the loan or dividend?
What is the policy's adjusted cost basis (ACB), cash surrender value (CSV) and fair market value (FMV)?
How, and when, will the borrowing be repaid?
What happens if you live longer than projected, interest rates rise, or the policy underperforms?

If the answer to any of these is unclear, the tax result is unclear too.

The tax rules that matter

Shareholder loans. If money borrowed by the corporation ends up with you as a shareholder, subsection 15(2) of the Income Tax Act can include it in your personal income. The one-year repayment exception in subsection 15(2.6) is narrow and generally does not protect a series of loans and repayments.

Shareholder benefits. Using corporate property personally, or having the corporation pay personal expenses, can trigger a taxable benefit under subsection 15(1). Indirect benefits can also be caught under subsection 246(1).

Policy loans and withdrawals. A policy loan, withdrawal, surrender or lapse can create a taxable policy gain under section 148, based partly on the policy's ACB.

Bank loan versus policy loan. A loan from a third-party lender secured by your policy is not the same as a loan from the insurer. The documents and the flow of cash need to be reviewed carefully.

Premiums. Premiums paid by a corporation are generally not deductible. A limited deduction may be available under paragraph 20(1)(e.2), but only if strict conditions are met.

Capital dividends. The capital dividend account (CDA) opportunity generally arises when a private corporation receives a death benefit. Paying a tax-free capital dividend requires a valid subsection 83(2) election and enough CDA. Electing too much can trigger Part III tax under subsection 184(2).

Warning signs

Promises of guaranteed tax-free retirement income
"No repayment required"
Claims of a "CRA-approved loophole"
No discussion of ACB, policy lapse, interest rates or collateral calls
Reliance on a sales illustration instead of written tax advice

Before you sign

Ask for the proposed transaction steps, the loan documents, the ACB calculation, guaranteed and non-guaranteed policy values, the repayment plan and a CDA analysis. Then have them reviewed independently by a tax professional who is not paid on the sale.

Remember: a product illustration is not a tax ruling, and "tax-deferred," "tax-contingent" and "tax-free" are not the same thing.

Get a second opinion

If you have been offered a corporate insurance strategy, or already have one in place, we can review the structure and tell you plainly what it does and does not achieve. Rise CPA LLP serves incorporated business owners and professionals across Ontario and Manitoba. Book a review or call (647) 847-1000.

This article is general information and is not tax advice for your specific situation. Speak with a CPA before acting on it.