Are Life Insurance Proceeds Taxable to a Corporation?

Life insurance proceeds paid out to a corporation are not taxable. While the premiums that a corporation pays are not tax-deductible, this provides an untaxed lump-sum amount to cover costs.

Continue reading to discover how a corporation can unlock this untaxed payout and the benefits associated with listing a corporation as the beneficiary of a life insurance policy.

Listing a Corporation as the Beneficiary

There are two types of life insurance that a corporation can purchase. Term life insurance provides basic coverage for a certain period, but permanent life insurance covers the individual until death.

Permanent life insurance includes universal, whole life, and term-to-100 policies that include investment components. These additional funds grow tax-free, and they can increase the proceeds of the policy and provide a cash value.

The details of a policy change depend on the exact permanent policy you decide on and the company you purchase it from, but listing the corporation as the beneficiary is a standard way to have the business pay premiums and collect the death benefit when it is time.

Premiums are not tax-deductible, but this allows for a larger lump-sum payment to the corporation at the collection of the policy. In most cases, this amount is not taxed, and it can be paid out tax-free to shareholders of the company in the form of a capital dividend.

The key here is making sure that any policy intended for corporate use is listed as the beneficiary and the policy owner. The shareholder should be listed as the covered person.

The intended use of the life insurance payout and the capital dividend account should be specified in the shareholder’s agreement. This limits any issues between shareholders or others in the company, and it ensures that the funds are used as intended.

Corporate Uses for Life Insurance

Corporations can use life insurance and the death benefit it pays out in a number of ways, most commonly to:

• Cover taxes and balance benefits paid to hers

• As collateral for loans

• To cover the cost of replacing key employees

• To facilitate a buy-sell agreement

When you list a corporation or a business as the beneficiary of a life insurance policy you give it plenty of opportunities to recover after the death of a shareholder.

Covering Estate Taxes and Balancing Benefits Paid to Heirs

Life insurance proceeds paid to a corporation can be useful in balancing out situations where the shares that an individual owns in a corporation make up a large portion of their estate, especially if some of the heirs are also involved with the business.

Usually, the shares are left to family members that are active in the company, and any assets that remain are distributed to the other heirs. In some cases, there is not enough to pay taxes on the disposition of the shares, and the death benefit can balance this out to pay beneficiaries that are not involved in the company.

A corporate-funded insurance policy allows the company to pay out dividend capital to the estate in the case of death. These funds can be used to fund any tax liabilities, and they balance out the value distributed between the beneficiaries.

Loan Collateral

In the case of a small business, lenders are less likely to approve a loan without a personal guarantee from the owner, and they may not approve a loan without a life insurance policy taken on key people for the length of the loan.

A corporate-owned policy can be used as collateral to secure the funds needed for a company to progress, and it is usually better to have one set up than to be left scrambling to secure a policy.

The policy takes care of the personal guarantee required to obtain a loan. Without a corporate policy to cover the cost of the debt, the shareholder’s estate is held liable if the business cannot pay.

It is beneficial to the company, the shareholder, and the shareholder’s family to cover this risk with a life insurance policy.

The cash value of a whole life policy can also be used as collateral to secure small-business loans, and businesses can tap into this amount as needed before the policy is claimed.

Coverage for Key Employees

Key employees are those that are essential to the performance of a company. While definitions vary, the point is that the loss of a key employee can affect the company as performance decreases.

The death of a key employee tasks the corporation with their replacement, but this is easier said than done. In most cases, it can take months to find a suitable replacement, and even then it will take longer for the replacement to have the same level of proficiency and efficiency.

Key employee coverage assists by providing cash flow that covers costs related to:

• Debts

• Decreases in performance

• Recruiting and/or training

Without a corporate-funded policy distributing a tax-free payout, losing a key employee can capsize a company.

Facilitating Buy-Sell Agreements

Private companies often use the untaxed payout from a life insurance policy to fund and facilitate a buy-sell agreement that a shareholder agrees to before their death.

This is seen often when other shareholders do not want the insured’s family to step into the business. It also protects them from family selling of the shares if they are not interested in taking up that responsibility.

The life insurance policy provides a way for shareholders to buy out the shares of the deceased, and it ensures that the business progresses as intended.

To ensure the money is untaxed this is usually done by paying out a capital dividend that then funds the purchase of shares from the estate of the deceased.

Final Thoughts

The untaxed proceeds from a corporate-funded policy can protect a business as it transitions out of the loss of a shareholder, but it is important you lock down a policy suitable for these uses. Contact Sim Gakhar for help finding a plan that serves the interests of your business and its shareholders.