Insurance Understood: Good vs. evil
By Medicine Hat News on January 6, 2018.
As a child I loved the TV show called Inspector Gadget. The main character was a detective who would always intercept the evil plans of the villain, Dr. Claw. (Side note: I am literally smiling as I type this.) Anyway, Inspector Gadget always figured out a way to solve cases and come out on top. This past summer was riddled with government tax proposals which has reminded me of Dr. Claw. This article will explain a strategy using life insurance shares that may save some tax for your business owners and help them come out on top. A life insurance (LI) share is usually created after the company is already in existence. Typically, a LI share is issued to the heirs of a shareholder. LI shares must be created before any life insurance policies are put in force. Under section 86 of the ITA, the corporate capital is reorganized, creating the shares. And initially, the shares will only have a nominal value. Going forward, the shares can be structured such that their value tracks the cash surrender value (CSV) and/or death benefit of a life insurance policy. Once the LI share is created the value of one or more specific life policies are attached to the LI share. On the death of the common stock shareholder the value of the CSV may not be attributed to the value of the shareholder’s common stock. This in turn means there is a lessening of capital gains tax in the common shareholder’s estate. Now the value of the life insurance policy is paid to the specified LI share. Then in turn a dividend is declared on that specific class of LI share, distributing the proceeds of the specified life policy to the specified heir through the capital dividend account. An example at this point would be useful. Let’s look at a scenario where we have a corporation owned by a father, with two sons. The father is the sole common shareholder, and only one of the sons will continue on in the business. Father wants to allocate some of the value of the corporation to the son who will not participate in the future workings of the corporation. The corporate capital is reorganized, creating the new LI share, with the non-participating son as the owner. The share will be issued at a nominal value, so there are no income tax repercussions for the son. Now the father applies for a life insurance policy that has the LI share as the beneficiary. On the father’s death, the CSV of the policy at the moment before death is allocated to the LI share, and will not impact the value of existing common shares. The death benefit is paid to the LI share and using a standard share redemption process, the LI share is redeemed for the value of the life policy. Depending on a few more factors the full amount may flow through to the LI shareholder on a tax-free basis through the capital dividend account. A potential risk in the use of LI shares exists if the LI shareholder (in this case the non-participating son) dies before the father and he has no spouse to take advantage of spousal rollover provisions. In this instance, the deceased son’s estate will be forced to add the FMV of the LI share to the rest of his estate value. This in turn means an increase in the value of the son’s estate, potentially creating an increased tax burden, with no actual funds being created to pay for the increased liability. An option to avoid this issue would be to create a family trust. The trust would own the LI share and would have more than one beneficiary for distribution of the LI share proceeds. For businesses it can feel like the government tax proposals can’t be beat. Yet there are professionals that act like Inspector Gadget to save the day. I suggest that you engage your professional team to review your specific situation. Steve Meldrum B.Mgt. CFP CLU is the founder of Swell Private Wealth Ltd. For over a decade he has specialized in helping individuals and businesses expand protect and perpetuate their wealth. For further information or tailored advice, contact him at 403-487-0490, steve@swellwealth.com or connect on social media. 8-7
