Tax surprises hurt

Have you ever gotten a tax surprise? I often have people come into my office sharing how they worked overtime and were surprised at how much taxes they paid on that overtime. I think there are two issues at hand. One is that they were not aware of the marginal tax rate that they were in. Secondly, they earned enough to bump them into a higher tax bracket. Any way you crack it, they were surprised and it was too late to make adjustments. This made me think about life insurance policies that have cash value.

Cash value within an insurance policy is very similar to equity in a house, in that it can be accessed in multiple ways for various reasons. However, when a business owner has cash value within an insurance policy, they need to be aware of a potential tax surprise. Cash value will be factored into the value of the shares prior to death (Income Tax Act – Subsection 70(5.3)). In other words, the cash value will create a capital gain on the shares that is taxable. Surprise! It sounds counterproductive to get insurance to avoid tax when it can actually contribute to the problem. However, with proper planning there are steps you can take to mitigate this tax surprise. The answer is life insurance tracking shares.

Life insurance tracking shares are a special class of shares that can track the cash value of a policy. This article is too short to explain all the features in great detail but I can convey the core concept. The tracking shares can be subscribed for before the policy is issued for a nominal price — $1. Those shares are placed in the name of the heir of the business owner’s estate, i.e. kids. When the shareholder dies, the value of the CSV is not attributed to the deceased, since the tracking shares are in place. From there, prior agreements will dictate that the shares are to be redeemed using the insurance proceeds tax free.

This is a simple step that can help you avoid a tax surprise. Of course, there is a lot more to it and professional guidance is required. Stay tuned on our various social media for to learn more.