Planning for all of life’s events is not always possible. The same can be said for the transfer of a life insurance policy to a new owner, whether an individual or corporation. While it’s best to avoid the need to transfer life insurance entirely – and the accompanying tax consequences, which can be complex and onerous – it’s not always possible to foresee every future circumstance, and so sometimes, it just needs to be done.
For example, you may own a policy personally and want to transfer it to your corporation. Or, your operating company owns the policy and now the business is to be sold. So, what should you consider before contacting the insurance company to make a transfer?
One of the key considerations is what the deemed ‘value’ will be of the transfer and whether that will result in a taxable gain of any kind. The rule is that the ‘deemed proceeds of disposition’ will be the greatest of the fair market value (FMV) of the consideration received (if any), the cash surrender value (CSV) and the adjusted cost basis (ACB) of the policy. A gain will arise when the deemed proceeds exceeds the ACB – and this gain is not a capital gain so is fully taxable as income! In addition, there are no tax-deferred rollovers for the transfer of life insurance to or from a corporation.
Let’s look at some situations which may lead to a policy transfer
What happens if you need to transfer ownership of a life insurance policy in the following situations… and remember to keep in mind the following terms related to valuing the policy for tax purposes: FMV means fair market value, CSV is the cash surrender value, and ACB is the adjusted cost basis (or the cost for tax purposes)
You transfer a life insurance policy to your corporation – you will have a gain for the deemed proceeds in excess of the ACB; however, there is no requirement that you receive FMV consideration on the transfer. Therefore, you could limit the proceeds to the greater of the CSV and the ACB. If the ACB of the policy is greater than the CSV, no gain will arise. If CSV is greater than ACB, a gain will arise equal to the difference.
Your corporation is being sold and you need to transfer the life insurance to yourself – if the consideration you receive is limited to the greater of CSV and ACB, this will limit the amount of the gain to your corporation, which seems like great planning; however, a shareholder benefit will result equal to the excess of FMV over that consideration! This is not a good result since your corporation would not get a deduction for the amount of the benefit – double tax results! If you instead pay FMV for the policy, the corporation will now have a taxable gain equal to the FMV less the ACB of the policy.
The operating corporation transfers a life insurance policy to your holding corporation – although the same shareholder benefit issues exist as noted above, the benefit can be eliminated by paying a dividend to the holding corporation that is equal to the FMV of the insurance policy and is paid by transferring the policy as payment of the dividend. The gain to the operating corporation is limited to the excess of the policy’s CSV and ACB. The dividend should be tax-free to the holding corporation if certain conditions are met.
You want to wind up your corporation – this might seem like the easiest solution to get the insurance policy into your hands but special rules apply that will result in a disposition of the life insurance policy at FMV, with potentially significant income tax consequences to you and your corporation.
You want to donate a life insurance policy to a charity – the same rules apply to determine the amount of the proceeds but there is no consideration received so proceeds would be limited to the greater of CSV and ACB. Your charitable donation receipt would be at FMV, which is a great result as the donation could be used to offset other income.
You want to transfer your life insurance policy to a family member – again, the same rules apply to determine the proceeds of disposition; however, there are rollover rules available in certain circumstances (between spouses and from a parent to a child for a policy on a child’s life).
Needless to say, there are lots of things to consider when transferring a policy using any of the methods outlined above. Always touch base with your tax accountant or lawyer before initiating a policy transfer to ensure you understand any resulting tax consequences.