As a business owner, you likely focus on running your company and protecting your family’s financial future. But there’s a hidden tax issue that could catch you off guard: the potential income tax liabilities from your corporation paying insurance premiums for you or your family members. Let’s explore this pitfall and how you can avoid it.
How Corporate-Paid Insurance Premiums Can Lead to Tax Issues
When we think about corporate taxes, we usually focus on dividends, wages, or bonuses as taxable income. However, many business owners overlook the tax consequences of having their corporation pay for personal insurance policies. While it might seem like a good idea to have your company cover these premiums, Canada’s Income Tax Act has rules that can turn this into a taxable event for the shareholder.
Subsection 15(1) of the Canadian Income Tax Act
A key tax rule business owners need to know is Subsection 15(1) of the Canadian Income Tax Act. This rule states that when a corporation provides a benefit to a shareholder, the value of that benefit must be included in the shareholder’s income.
One common example is when a company pays the premiums on a life insurance policy that benefits the shareholder or their family members. If your corporation pays the premiums and the beneficiaries are your family, not the company, the CRA may classify this as a taxable benefit.
Real-World Example: A Costly Mistake
Take the case of a client I recently worked with. This entrepreneur owned a thriving business and had his company pay for life insurance policies that covered him and his wife, with the beneficiaries being his spouse and children. At the time, it seemed like a smart way to safeguard his family’s future.
Unfortunately, the CRA saw it differently. The large premiums, combined with the personal beneficiaries, led to a reassessment several years later. The CRA determined that the premiums were a taxable benefit under Subsection 15(1), and the resulting tax bill was over $500,000. This unexpected cost left the business owner scrambling to cover the liability.
Lessons for Business Owners: How to Avoid Tax Traps
This example shows how easy it can be to overlook these tax rules, resulting in significant financial consequences. Here are some best practices to help you avoid similar pitfalls:
1. Structure Life Insurance Policies Correctly
If your corporation is paying the insurance premiums, ensure the corporation is the beneficiary. This avoids the risk of the CRA classifying the premiums as a shareholder benefit, which could lead to a hefty tax bill.
2. Get Professional Tax Advice
Always consult with a tax professional or financial advisor before entering into any insurance arrangements where corporate funds are involved. A qualified advisor will ensure that the insurance structure aligns with both your business and personal tax strategies.
3. Review Your Policies Regularly
Tax laws and business circumstances change over time. Regularly reviewing your insurance policies can help ensure that your beneficiaries and policy ownership remain tax-efficient.
4. Be Cautious with Immediate Financing Arrangements (IFA)
While IFAs can offer liquidity, they also carry tax risks if not structured correctly. Make sure both the financing and beneficiary designations are aligned with tax rules to avoid unintended consequences.
5. Keep Detailed Documentation
Always maintain clear records of any insurance policies paid by the corporation, including the reasons for beneficiary designations. These records can be invaluable in the event of a CRA audit or reassessment.
Be Proactive to Prevent Unexpected Tax Bills
The story of my entrepreneur client is a cautionary tale. It highlights how important it is to proactively manage corporate insurance policies to avoid unintended tax liabilities. A simple review of your policies today could save you from a large, unexpected tax bill in the future.
If your corporation is paying insurance premiums, now is the time to sit down with a CPA or tax advisor. Make sure your policies are structured properly, and your business decisions remain tax-efficient. Taking these steps now could save you a lot of financial stress later on.