Benefits for Business Owners: 

Cash value life insurance can be a strong tool for business owners as it helps manage risk, provides security for their families and businesses, and is an important component in legacy planning. Properly structured, it provides a great place to save money within a corporation while providing many powerful ‘living benefits’ that an owner can access throughout their lifetime for any purpose.

In my work with business owners and their advisors, I see how the recent introduction of the passive investment income rules will impact business owners with taxable investment income. In addition, I also see possible remedies that are not well understood by advisors or business owners.

Over the past 6 months, we have been presenting an educational seminar to CPAs on how to help their clients save their small business tax deduction and benefit from the living benefits of cash value life insurance. These seminars have prompted some ‘frequently asked questions’ from the CPA seminar participants

Here are the top 3 questions that we get asked by CPAs about the impact of corporately owned life insurance:

1. Is the growth in an exempt cash value life insurance policy subject to the passive investment income rules?

No.

An explanation: The passive investment income rules were introduced in the 2018 Federal Budget and now affect taxation years ending after December 31, 2018.  

The rules result in a reduction in the small business deduction (SBD) if the corporation (or associated corporations) has adjusted aggregate investment income (AAII), commonly called passive income, that is greater than $50,000 in the previous year. The SBD is reduced $5 for every $1 of passive income over the $50,000 threshold resulting in the elimination of the SBD at $150,000 of passive income.

However, the growth in an exempt cash value life insurance policy is not included in the AAII calculation and therefore is not subject to the passive investment income rules.  Yet, any income gain arising from the disposition of a policy would be included in the calculation and would be subject to the passive investment income rules.

2.  How do you access the cash value for business, investing or other purposes?

A life insurance policy owner can access a policy’s cash surrender value (CSV) in one of three ways:

  1. Withdrawing the CSV of the policy by either a partial or full surrender of the policy;

  2. Obtaining a policy loan from the insurance company; or

  3. Assigning the CSV as collateral for a loan from a third-party bank.

 The first two options may result in a possible disposition and an income gain may result if the proceeds of distribution are greater than the policy’s adjusted cost base (ACB). The collateral assignment of a life insurance policy does not result in a disposition for tax purposes; however, qualifying for the loan may be problematic and, therefore, a policy loan can always be a last resort for keeping the insurance in place.

 

3.  How does corporately owned insurance affect share valuation?

An individual is deemed to dispose of capital property for proceeds equal to fair market value (FMV), and where the individual owns shares in a corporation, the shares must be valued. A corporately owned policy is valued at cash surrender value (CSV) if owned by the corporation of the life deceased shareholder or any individuals not dealing at arm’s length with the deceased shareholder. However, life insurance the corporation owns on any other surviving shareholder or employee must be valued at FMV and not CSV.

 

Need more information?

I work with CPAs and other advisors to provide their clients with situation-specific solutions that reduce tax and preserve wealth.

If you’d like to know more or have a specific question, please reach out. I am happy to share my resources to you or your team.

Ryan Witmeyer

Learn more about the benefits of corporately owned cash value life insurance here.