Update: Taxation of Life Insurance and Strategies

Update: Taxation of Life Insurance and Strategies Presented to: NYDCAA Prepared By: Joe Yukich CPA, CA joe@jyukichca.com 416-432-5429

Legislative Update • 10/8 Strategy • Universal life policy and loan arrangement all in one. • Earn 8% (exempt) in plan and pay 10% (deductible) on loan • Challenged by CRA • Eliminated in March 2013 Federal Budget • Final Legislation

Legislative Update • 10/8 Strategy (con’t) • Final Legislation effective after 2013 • Applicable to pre and post March 2013 policies • Interest deduction denied (S. 20(1)(c)) • Collateral insurance deduction denied (S. 20(1)(e.2))

Legislative Update • 10/8 Strategy (con’t) • Final Legislation effective after 2013 • Reduction in CDA death benefit • Offending collateral loan outstanding immediate before death • To facilitate restructuring, no gain on cash withdrawals to pay down collateral loans • Withdrawal must be made after March 20, 2013 and before April 2014 • Adverse consequences above still apply after 2013

Legislative Update Leveraged Insured Annuities (LIAs) • Life annuity and life insurance policy • Collateral to borrow funds • Interest expense (S. 20(1)(c)) • Collateral insurance deduction (S. 20(1)(e.2)) • CDA on death to private company

Legislative Update Leveraged Insured Annuities (LIAs) (con’t) • March 2013 Federal Budget Changes • Final Legislation • Grandfathering for loans in place at Budget date with no subsequent increase • Interest deduction ok if S 20(1)(c) otherwise permits • Collateral insurance deduction denied S. 20(1)(e.2)

Legislative Update Leveraged Insured Annuities (LIAs) (con’t) • March 2013 Federal Budget Changes • Final Legislation • Annuity premium included in valuing private company shares at death • Policies denied exempt status and subject to accrual tax • CDA addition denied on death benefit

Life Insurance Strategies Tax Effective Transfers of Life Insurance Between Non Arm’s Length (NAL) Parties • Overriding Rule for Transfer of Life Insurance Policies • Deemed proceeds = deemed cost = Cash Value of policy or nil if non-cash policy • Does not apply to taxable benefit on transfer (so be careful)

Life Insurance Strategies Tax Effective Transfers of Life Insurance Between Non Arm’s Length (NAL) Parties • Consider transfer of low cash policy on shareholder’s life to Private Co. for FMV to obtain tax-free cash from Private Co. • Deemed proceeds = 0 (i.e. not a cash policy) • Deemed cost = 0 = ACB to Private Co. • If FMV of policy = $100,000 then shareholder receives $100,000 tax-free from sale proceeds • Not affected by February 2014 Federal Budget but stay tuned.

Life Insurance Strategies Tax Effective Transfers of Life Insurance Between Non Arm’s Length (NAL) Parties • Consider other factors: • Future sale of company with life policy • Beneficiary of policy likely should be corporation • Other shareholders and impact on estate plan • Obtain valuation - specialty • Other

Life Insurance Strategies Use life Insurance to Defer Death Tax To Next Generation EXAMPLE • Dad owns 100% of PC Co. common worth $5 million and leaves to Mom at his death. • Mom leaves shares to children at her death • No capital gains tax at Dad’s death but payable at Mom’s death in amount of $1.2 million. • May require bank financing (if available) or partial liquidation of PC Co. shares to pay death tax.

Life Insurance Strategies Use life Insurance to Defer Death Tax To Next Generation EXAMPLE (con’t) Freeze Dad’s Shares and Create FT • Convert Dad’s PC Co. common shares to $5 million fixed value preferred shares (tax-free) • FT subscribes for Opco common shares for $100. • Opco buys $5 million life insurance policy on Dad and pays for from after-tax profits of business

Life Insurance Strategies Use life Insurance to Defer Death Tax To Next Generation EXAMPLE (con’t) Freeze Dad’s Shares and Create FT • At time of Dad’s death, PC Co. preferred shares transferred to Mom tax-free. • PC Co. redeems Mom’s preferred shares tax-free with Capital Dividend Account (CDA) created from life insurance proceeds on Dad’s death. • No capital gains tax at Mom’s death and no need to incur bank debt or liquidate PC Co.

Life Insurance Strategies Use life Insurance to Defer Death Tax To Next Generation EXAMPLE (con’t) Freeze Dad’s Shares and Create FT • Consider transfer of existing policy on Dad to Private Co to effect deferral to next generation • Extract tax-free cash

Update: Taxation of Life Insurance and Strategies