If you’re a company owner who personally owns a life insurance, you may be able to extract surplus funds from your company, tax-free. The technique involves transferring your personally owned policy to your company, but be conscious that the tax guidelines concerning the transfer are various from other asset transfers.
Although normally you are able to transfer an asset from personal name into corporate name utilizing a tax-deferred “rollover,” the section of the Tax Act that usually permits such a transfer is not applicable towards the transfer of life insurance policies. Instead, the transfer of your policy to your company is considered to become a disposition for tax purposes. Special guidelines govern the taxation of this transfer when it’s between non-arm’s length parties, such as a shareholder and a corporation.
Under the Act, your proceeds of disposition as the shareholder are deemed to be equal towards the “cash surrender value” from the policy. The cash surrender worth is the amount of cash in a life insurance plan that the insurance company will pay the policyholder if he or she surrenders the plan back to the organization.
The chance to extract surplus cash arises if the existence insurance plan has a fair marketplace worth — as determined by an actuarial valuation — which is higher than the cash surrender value, if any. The most typical cause for the reasonable marketplace worth to become high occurs where the price of purchasing a new policy today would significantly exceed the price of continuing to spend the premiums on the old plan, due to advanced age, poor health or decreased life expectancy.
So, to extract the cash from your company when the fair marketplace worth is greater than the cash surrender worth, your organization would merely spend you cash (or a promissory note) equal to this fair market value. The excess over the cash surrender value is yours to maintain, tax-free. Only the distinction between the cash surrender value, if any, and the adjusted cost basis of the policy will be taxable.
When the organization buys the plan, its new adjusted cost basis is deemed to become the cash surrender value, not the fair marketplace worth. This is beneficial because upon death, the death benefit proceeds, much less the adjusted cost basis of the plan, can usually be paid out tax-free like a capital dividend.
But take note: Although the CRA is well aware of this strategy and agrees with the technical tax result, it has stated “it isn’t clear that the above outcome is intended in terms of tax policy (and it has) brought this situation towards the attention from the Department of Finance.”
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