For years, life insurance has been an integral part of business owners’ tax and financial plans. While these policies help you leave money behind to your heirs, certain policies, called exempt policies, used to have tax advantages over many other types of investments. The rules surrounding the taxation of exempt tax policies remained essentially unchanged from 1982 until 2017. As of Jan. 1, 2017, a new reform has come into force that has dramatically altered the landscape.

Tax Treatment of Life Insurance Policies

When businesses structured as corporations serve as the beneficiary of a life insurance policy on its owner’s life, the insurance benefit that the company receives upon the death of the shareholder credits almost entirely to the company’s capital dividend account. The corporation then pays tax-free capital dividends to the deceased shareholder’s estate. This makes it very advantageous for corporations to take out life insurance on their shareholders, especially later in their lives.

Extended Benefits Via Investment

Small business owners often use this beneficial tax treatment, especially when other shareholders plan to continue those companies afterward and need to buy out the owners’ estates. Under the earlier rules, exempt insurance policies allowed insured persons to pay the premium in an accelerated manner and to pay amounts greater than the premiums into the policies. As a result, they could generate a tax-free return by using that extra cash in the policy for investment. Because taxation only occurs on this extra money after the insured person’s death, and upon winding up the policy, this method offered a lucrative tax deferral. This worked much the same way as a registered retirement savings plan, but without the deduction for contributions.

The 2017 Changes and Their Implications

For years, the Canada Revenue Agency acknowledged that though most of the tax planning surrounding life insurance policies was legal, the agency was uncomfortable with some of the advantages it created. The new rules were instituted to curb the advantages described above and to bring life insurance policies back closer to their original purpose. Essentially, the 2017 rule changes seek to accomplish two goals: reducing the investment portion of exempt policies by lowering the amount those insured can pay into the policy and modifying the attribution of death benefits to the capital dividend account to take into consideration more realistic life expectations. Policies entered into prior to the end of 2016, which were grandfathered in, continue to use the old rules as long as the policies remain unchanged.

These estate planning techniques often have highly technical setups, and the changes to the law continued this complexity. If you use a life insurance policy in this fashion, you should consult with your tax advisor before making any changes to your policies, as doing so could mean losing your advantaged status. No matter your business setup or how you plan for retirement and your eventual passing, QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.