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Business Insurance
Part 1Working with Business
Owners
Jorge Ramos, CFP ,CLUDirector of Advanced Marketing
A PARTNER YOU CAN TRUST.
> Self Employed
> Partnerships
> Incorporated private business
> CCPC
> Publicly listed corporation
> Professional Corporations
Business Structures
> Self Employed> Commission income or sales> Can deduct expenses> Net profit taxed as personal income
> Partnerships> Commission income or sales> Can deduct expenses> Net profit added taken as income proportionately by
each partner
Business Taxation 101
> Incorporated Private business> General corporate tax rates
> 26% (11% Provincial, 15% Federal)> 25% (manufacturing, farming, mining)
> CCPC> 15.5% (4.5% Federal, 11% Provincial)
>On first $500,000
>Publicly Traded companies>Do not qualify as CCPC
Business Taxation 101
> CCPC> Corporation resident in Canada> 51% controlled by Canadians> Not listed on a stock exchange> Not owned by a publicly traded firm
Canadian Controlled Private Corporation
> Lower corporate tax rates> 15.5% vs. 26%
> An additional month to pay taxes
> Enhanced investment tax credits
> Qualifies for Capital gains exemption - CGE> First $750,000 of capital gains on shares is tax-free
CCPC - Advantages
> First $750,000 of capital gains are tax-free> Qualified small business shares> Qualified Farm property
> 50% of assets “actively” used in the business for the last 24 months
> 90% of assets “actively” used in the business at time of sale
> Shares owned by individual for last 24 months
Capital Gains Exemption
> Everyone is an employee, including Founder
> Company can own Life insurance on employees
> Requires resolution of the board
> Insurance premiums not tax deductible
Publicly Listed Corporation
> Can only carry on business of profession
> Majority must be owned by professionals (voting shares)
> Non-professional spouse/children can also be shareholders (non-voting shares)
> Cannot be a numbered company
Professional Corporations
> Income higher then needed for lifestyle
> No personal non-deductible debts
> In highest personal tax bracket> Spouse and children in lower tax brackets
> Creditor protection needed
> Deductions against income needed
When to set-up a Professional Corp
> Qualifies for small business tax rates
> Expenses deduction
> Tax deferral> Corporate tax vs. personal tax rates> Dividend vs. salary
> Income splitting> Hiring family members> Dividend sprinkling
> Creditor Protection
Professional Corp. – Advantages
> CGE – triggered on sale of shares> Cannot sell professional corp. shares easily
> No protection against Professional negligence
> Increased costs to administer
> Increased regulation and complexity
> Employee health tax charged on income
> Business losses cannot be flowed to shareholders
Professional Corp. - Disadvantages
> Income earned at a corporate level may ultimately end up being distributed to someone and as a bonus/income or as a dividend to someone personally.
> Income should be Tax Neutral, ie: taxed equally whether income is earned corporately or personally.
> There are various mechanisms used by CRA to ensure that this is true:
> RDTOH – Refundable Dividend tax on hand> CDA – Capital Dividend Account
Theory of Tax Integration
> Acts as a disincentive to accumulate investment income in the corporation.
>The federal government levies a tax on any investment income earned by a CCPC, the tax goes into the company’s RDTOH account (functioning like an inventory) with CRA and is refunded to the CCPC when it pays a taxable dividend to shareholders.
>For every $3 in taxable dividends that are paid to shareholders, the company is refunded $1 up to the balance of the RDTOH account.
RDTOH – Refundable Dividend Tax on Hand
> The CDA is a notional account. > It is not an actual bank account but rather an accounting notation
> The CDA tracks any amounts that a company receives tax free, such as:
> Insurance death benefits, net of ACB> Tax-free portion of capital gains> Capital dividends received
> The CDA amount allows the corporation to pay a tax-free capital dividend from their retained earnings.
> Must be paid to a CDN resident> Must be a CCPC – CDN controlled private Corp.
CDA - Capital Dividend Account
> CDA = Life insurance death benefit – ACB> Life insurance death benefit
> net of policy loans> not net of collateral loans> Applies to permanent and Term policies> Applies whether there is cash value or not
> Notes:> ACB usually goes to zero after 20+ years, cannot be negative> CDA has to be paid out equally to all shareholders of the same
class
Calculating CDA
> ACB – Adjusted Cost Basis> Ensures that corporate money gets taxed properly in
personal hands> The ACB of policy tracks the original premium paid by a
company for life insurance minus the NCPI
> Formula> Premiums Paid increase ACB> NCPI decreases ACB
ACB
> NCPI – Net Cost of Pure Insurance> Net amount at risk (NAAR) for the year multiplied by the
probability of death in that year, ie: similar to T1 rates>Based on 1975 Select and Ultimate mortality table>Costs for any benefits or riders removed>Removes any ratings on substandard risks
NCPI
> CDA = Life insurance death benefit – ACB> Life insurance death benefit
> net of policy loans> not net of collateral loans> Applies to permanent and Term policies> Applies whether there is cash value or not
> Notes:> ACB usually goes to zero after 20+ years, cannot be negative> CDA has to be paid out equally to all shareholders of the same
class
Calculating CDA
> Client Male 50, Std. NS, Corp.
> Policy Death benefit $5 million UL face only
> Premium $200,000 per year for 10 year
> Min Level COI Cost $66,219.24>
> ACB in year 5 $ 945,709
> ACB in year 20 $1,333,791
> ACB in year 30 $ 0
Impact of CDA
NCPI vs COI
($54,291 vs $331,096)
($666,209 vs $2 million)
> Death Benefit $5,000,000
> ACB $ 945,709
> CDA Credit $4,054,291
> How much did Corp. receive from InsCo.?> $5,000,000
> How much could Corp pay tax free to shareholders?> $4,054,291
> What happens to the rest?
Impact of CDA – Year 5
> Death Benefit $5,000,000> ACB $ 945,709
> CDA Credit $4,054,291
> Tax free Capital dividend paid $4,054,291
> Taxable dividend paid $ 945,709
> Tax paid on dividend $ 308,017
> What is the net death benefit received by shareholders?> $4,691,983
Impact of CDA – Year 5
> Problem:> Potential death benefit shortfall created by CDA/ACB> Net death benefit may fall short of required amount
> Buy-sell
> Solution:> Face plus fund plus ACB
> Increases face amount so that CDA paid is equal to or greater than original death benefit
> Removes risk of the ACB tax grind on CDA> Removes risk of underinsuring the need
CDA Tax Trap
Deductibility of Insurance Premiums
> Premiums paid by a corporation for a life insurance policy are generally not tax deductible
> Considered a capital outlay and not an expense
> Exceptions:
1.Group insurance premiums
2.Charitable gifting of a life insurance policy
3.Collateral insurance
2. Charitable gifting of a life insurance policy
> Policy assigned to charity> Charity issues a tax receipt equal to actual premiums
paid > Death benefit does not trigger a tax receipt
> Policy not assigned to charity> Charity issues a tax receipt for value of death benefit
upon receipt of death benefit proceeds> No tax receipt for annual premiums
3. Collateral Insurance
1. Client secures a loan from a restricted financial institution
2. Lender requires a policy as collateral to secure the loan
3. The policy is assigned to the lender
4. Loan proceeds are invested in a qualified income generating investment
5. Interest on loan must be tax deductible
Collateral Insurance - Interest Deductibility
> Loans must be invested to earn income> Rent, dividends, profit, interest> Capital gains does not qualify
> Interest must be paid or payable in the year
> There must be a legal obligation to pay the interest
> Interest deduction can only be taken by policy owner
> Policy loan interest must be confirmed by insurer> Form T2210
Collateral Insurance – Allowable deduction
> Step 1> Lower of:
> NCPI for the year and > Premiums actually paid in the year
> Step 2> Pro-rated by amount applicable to loan
> Example: Loan Amount = $250,000
Insurance DB = $1 million
Deductible amount = 25% of step 1 amount
MTAR
> Maximum Tax Actuarial Reserve
> Magical Table of Allowable Room
> The maximum premium a policy owner can deposit into a policy, tax sheltered.
> The maximum amount that an insurance company can claim as a policy reserve.
MTAR - Two Major Tests
> Exempt Test Policy (ETP)> designed to measure the funding level of a life insurance
policy relative to its death benefit
> 250% or “Anti Dump-In” Rule> applies if the accumulating fund on the tenth anniversary
or any subsequent anniversary date, exceeds 250% of accumulating fund on the third preceding anniversary date
Exempt Test Policy (ETP)
>Based upon the actuarial reserves required for a 20 pay policy to endow (cash surrender value equal to death benefit) at age 85
00.10.20.30.40.50.60.70.80.9
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0 20 40 60 80 85
ETP
Issues with Exempt Test
> Rules in Regulation 306 of Tax Act outlining exempt policies are open to interpretation
> Based on CSV or Fund Value ??> Increase in Fund value considered new deposit ??
> Test ends at age 85> No insurance needed to tax shelter funds
> Changes coming in 2014
250 percent rule (anti dump-in rule)
> 10th year test
> Maximum deposit in year 10 is
> Year 7 Fund value times 250%
> Growth in fund value is considered new money
> Prior to 7th Year
> Need to start contributing more than the minimum
Income Statement
> Premiums paid minus increase in CSV
= Net Insurance Expense
> Increase in CSV minus premiums paid
= Income
Corporate Insurance Advantages
> Personal marginal tax rates vs. Corporate rates> 46.4% vs. 15.5%
> Ease of administration> Buy-Sell premiums shared equally> Multiple policies centrally owned
> Capital dividend account
Corporate Insurance Disadvantages
> CDA Tax trap
> Increased value to corporate shares> Increases capital gain
> Opco vs. Holdco> Potential sale of Opco> CCPC/CGE offside risk