If your client owns their own business, incorporation is a must since corporate structures have significant benefits such as limited liability, continuity of the business, easier access to capital, lower income tax rates with small business tax deductions and a potential tax deferral.
However, has your client considered corporate-owned insurance? Not to be confused with insurance purchased for the business (also a must), corporate-owned insurance is a life insurance policy purchased by the corporation on the life of a shareholder in order to protect the business in the case of the shareholder’s death.
Consider the following advantages of corporate-owned insurance for your client:
Corporate vs. Personal Dollars – In today’s tax world, it is far more economical for your client to purchase their life insurance using those corporate dollars rather than their personal income. Why? If your client’s business qualifies them for a small-business tax deduction, they could potentially pay a tax rate of only 11% in comparison to an individual with an assumed marginal tax rate of 50%. The corporation will have far more after-tax dollars available to pay for life insurance premiums and in most cases; these insurance premiums are not deductible to either the corporation or the individual.
Alternative Investment – The Income Tax Act allows for funds (subject to a maximum) to be invested and grow on a tax deferred basis within an insurance policy, which effectively creates an RRSP-like mechanism within the corporation. Because of this preferential tax treatment, corporate insurance can create enhanced asset values in comparison to investing the same amount in a corporate investment account. Keep in mind though that withdrawals could still be subject to tax.
Flexibility – Like all other assets, an insurance policy can be used as collateral with a financial institution to obtain a loan, the proceeds of which can be used for the business or put towards retirement.
Added Value – Corporate-owned insurance allows your client to realize other unique business strategies such as the funding of buy-sell agreements or key-person coverage.
Use of the Capital Dividend Account – The CDA is a vital part of estate and tax planning for shareholders since life insurance proceeds are received tax-free by a corporation and are credited (net of the adjusted cost basis of the policy) to the CDA, which in turn can be paid to the shareholders as a tax-free capital dividend.
Be aware that there are still a few matters that need to be considered when discussing corporate-owned life insurance with your client. It is not advisable to have the insurance policy owned within the operating business since the asset would be vulnerable to creditor claims and if the operating corporation were sold, it would be impossible to transfer the insurance to the shareholder in a tax-efficient way. Instead, the insurance should be held in a holding corporation with the operating corporation as the beneficiary. Also, keep in mind that when your client is dealing with multiple shareholders, there are additional issues to consider and a shareholders’ agreement is paramount.
Speak to your clients today to see if corporate insurance is right for their business.