Life insurance changes could impact tax-planning strategy for entrepreneurs
Recent changes to federal tax rules related to life insurance policies could have a significant impact on tax, estate and financial planning for some entrepreneurs. The good news: there’s still time to act and adjust your insurance strategy before these changes take effect in 2017.
It’s important to note that tax rules related to life insurance policies have essentially remained unchanged since 1982. Since that time, life expectancies have increased and new insurance products have come on the market, necessitating some legislative adjustments.
Under the new insurance rules, pre-existing policies will be “grandfathered” except to the extent life insurance is added to the policy where medical underwriting takes place after 2016, or if a term policy is converted into a permanent policy after 2016.
One key change relates to corporate owned insurance and the restriction on proceeds that will be credited to the capital dividend account (CDA) and ultimately paid out tax free. The calculation is complex, but for policies issued after 2016, the net cost of pure insurance (NCPI) will be lower, resulting in changes to the adjusted cost base of the insurance policy (ACB) and thereby reducing the ultimate addition to the CDA.
Another key change relates to the transfer of personally held life insurance to non-arm’s length corporations. Under the previous rules a shareholder could transfer a personal life insurance policy to his or her corporation and extract the fair market value of the policy essentially tax free. Upon the owner’s death, the proceeds from these corporate owned life insurance policies would be paid into a corporation and transferred out to the estate tax-free through the CDA, without restriction.
To illustrate, let’s say, for example, that you owned a $1 million life insurance policy with a fair-market value (FMV) of $300,000. You could have transferred the life insurance policy into your corporation then extracted the $300,000 free from tax. Upon death, the corporation would collect the full $1 million value of the life insurance policy, which would be paid out to the shareholder from the capital dividend account tax free. In the end the shareholder/estate would have extracted $1.3 million without paying a cent in tax.
The Canada Revenue Agency (CRA) closed this “loophole” effective March 22, 2016. The $300,000 that was extracted in the example above will reduce the credit to the CDA thereby creating a taxable dividend when the insurance proceeds are paid out to the estate.
These changes apply retroactively to any policy transferred into a corporation by a person from 1999 to March 22, 2016.
If you haven’t already transferred funds from a personal life insurance policy to your corporation, it’s too late to take advantage of this “loophole.” If you have, note that there will be an adjustment to your CDA.
Another change relates to the deductibility of corporate owned life insurance premiums. In general terms, when a life insurance policy is assigned to a lending institution as collateral on an outstanding loan, the premium paid on the policy is a deductible expense. Under the new rules a reduced percentage of the premium paid will now be tax deductible.
As always, contact your accountant and insurance advisor to discuss these changes and their impact on your personal and corporate tax, financial and estate planning strategy.
Hartley Cohen, Partner