If you are like most business owners, the majority of your wealth is represented by your shares in your business and your shareholder loan (those personally taxed funds loaned to the corporation to finance its operations).
Where a Unanimous Shareholder Agreement (USA) is in place, the death provisions often provide that a deceased’s interest (shares and shareholder loans) are to be purchased either by the surviving shareholders, the corporation or a combination of both. Often a company may have to devote many years of income to fund the purchase of a withdrawing shareholder’s interest.
Shareholder loans have often been used to finance the company and there is generally no liquidity to repay the loans. Therefore a repayment often has to be paid out of new after tax corporate dollars.
In addition, a deceased’s estate will pay up to 27.7% tax depending upon how the shares are purchased. However, a deceased could utilize the $750,000 Enhanced Capital Gains Exemption for part of the purchase.
The lack of liquidity and significant tax burden can be solved, at least upon the death of a shareholder, by the use of life insurance. Life insurance received by a corporation is added to an account tracked by the Canada Revenue Agency (CRA) called the Capital Dividend Account (CDA). Dividends can be paid to the shareholders from this account on a tax free basis. Upon the death of a shareholder the corporation would receive insurance proceeds and repurchase the shares from the deceased’s surviving spouse or personal representative tax free as a deemed dividend. As another option, the company could pay a tax free dividend to the surviving shareholder to use to fund the actual purchase of shares.
Life insurance can also be an important part of an estate plan where shares of a business are left to children active in the business and there is a need to equalize the estate with other children. Insurance can provide the necessary capital to provide for the children who are not or will not receive shares. This allows the estate to leave the shares to the parties whom the deceased wanted to have running the business.
The cost of life insurance can be purchased on a Term or Lifetime basis. Each business owner will have preferences as to how long they wish coverage to stay in place.
A knowledgeable insurance advisor can assist in selecting the most appropriate product to be considered.
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Thanks to Gary Clark of Clark Insurance for providing much of this content.
