Are you the owner-manager of an incorporated business? If so, have you thought about the risks your business faces if you were to unexpectedly pass away? If you were to pass away while you are still running the business, there could be a deemed disposition of the shares that you owned at the time, which can result in a major tax bill to your estate.
What is a Deemed Disposition of Shares?
When a shareholder dies, their shares will either pass on to their spouse, if they have one, or there will be a deemed disposition of the shares, in which case the estate will be liable for the taxes of that disposition. A deemed disposition essentially refers to an assumption that the shares were disposed of, or sold, just prior to the shareholder’s death. When this assumption is made, it creates a tax burden on the amount the shares would have sold for. If a shareholder passes the shares on to their spouse upon their death, there is no deemed disposition. This burden will be deferred until the death of the spouse. However, if the shares are passed on to the shareholder’s children, there will be a deemed disposition of the value of the shares.
How would these taxes be paid and who would pay them? If no alternative plans have been made, this payment will generally come from the overall value of the estate, which will then have the effect of reducing the overall amount payable to the beneficiaries. Even if your spouse is the beneficiary of the shares, he or she may not want to retain the shares and will have to pay the taxes on any profits received in the sale.
What is Corporate Life Insurance and How Can it Help with a Share Transfer?
We all know that life insurance can be taken out by individuals, but it can also be taken out by a corporate entity. In the case of an owner-manager of a corporation, the business could purchase a policy on the owner’s life. In this scenario, the corporation would pay the insurance premiums, and also be listed as the policy’s beneficiary. In the event of the owner-manager’s untimely death, the proceeds from this life insurance policy can be used to pay the taxes on the deemed disposition of the owner’s shares. Their family will not have to borrow money from the bank or use proceeds from the estate that would otherwise go to the beneficiaries.
Additional Advantages of Corporate Life Insurance
There are additional advantages to using corporate life insurance. The first is, while the premiums paid by the company for the policy are not tax deductible, the proceeds from the policy will not be taxable for the company. The benefit this creates more than offsets the costs of paying for the policy.
The second advantage is that any proceeds from the life insurance policy that are not needed to pay the tax on the deemed disposition of shares could be used to pay off some/all of any liabilities on the company’s balance sheet. For example, if you intend for your child or children to take over the family business after your death, helping them to pay off some or all of long-term debt held by the business will make their transition to managing your company that much easier.
The third benefit also relates to any debt that your company has on its balance sheet. When lending money to borrowers, banks do not like to take risks. When the business owner has a robust corporate
life insurance policy to act as collateral, this risk is significantly reduced. Some banks will require that the business have such a life insurance policy in place before they will even consider extending a loan.
If you are a business owner who would like assistance with succession planning or advice on corporate life insurance, the accounting professionals at Edelkoort Smethurst Schein CPAs LLP can assist you. Please contact us by telephone at 905-517-2297 or reach out to us online.