Many times, a recommendation is made for life insurance to be owned within a corporate structure. If the company names itself as the beneficiary under the contract, the premium payments generally do not give rise to any taxable benefit to the shareholder(s).
The primary advantage of corporate ownership is that it usually takes less pre-tax income to fund the required premiums. The planning rule of thumb is that, if all other things remain equal, the entity with the lowest tax rate should pay any non-deductible expenses, and life insurance premiums are generally not tax deductible.
The primary disadvantage of corporate ownership is the loss of creditor protection. Individually-owned life insurance enjoys special protection under the Bankruptcy Act of most provinces under certain specific circumstances. To the extent the beneficiary is within a prescribed class of relatives of the insured person, the policy is exempt from seizure by creditors of the owner. Since a designated corporate beneficiary cannot have a qualifying family relationship with the insured person, creditor protection is not available, thus exposing the contract to all creditors of the corporation.
When the policy is acquired by the corporation, it is important to properly record the purchase, the premium payments and any buildup of contract cash value in the books of the corporation. The International Financial Reporting Standards (IFRS) and Accounting Standards for Private Enterprises are silent as to the financial reporting of corporate owned life insurance. Guidance in respect of accounting for a life insurance policy can be taken from the United States, where the financial accounting standards board has released a statement.
Consider the following example:
|$10,000||premium due annually for 10 years, after which the policy is paid up|
|$3,000||cash value at the end of year one|
|$8,000||cash value at the end of year two|
|$98,000||cash value at the end of year nine|
|$110,000||cash value at the end of year ten|
|$115,000||cash value at the end of year eleven|
The following are the accounting entries:
|DR||Cash Value||3,000||balance sheet|
|DR||Insurance Expense||7,000||income statement|
|To record premium payment in year one and recognize year end cash value of 3,000|
|DR||Cash Value||5,000||balance sheet|
|DR||Insurance Expense||5,000||income statement|
|To record premium payment in year two and increase of 5,000 in cash value|
|DR||Cash Value||12,000||balance sheet|
|CR||Insurance Gain||2,000||income statement|
|To record premium payment in year ten and increase of 12,000 in cash value|
Debit (DR) and Credit (CR) are accounting terms and are used to ensure that the entries are always in balance — the amount(s) of debit must be equal to the amount(s) of credit.
Insurance expense and insurance gain would be reported on the Income Statement of the corporation. Even though this was reported as an accounting expense or income, it would not be tax deductible or taxable. This life insurance expense recorded on the Income Statement of the company would be added back or deducted when determining the taxable income of the company.
The accounting entries (as shown in the example above) should begin with the known facts and ensure that the entry is balanced with an expense or revenue adjustment. In year one, $10,000 was drawn from the bank and the cash value within the policy increased by $3,000; therefore, the insurance expense had to be $7,000. In year two, $10,000 was again drawn from the bank and the year-end cash value within the policy was $8,000; therefore, the cash value had to be increased by $5,000 and the offsetting insurance expense would be $5,000. In year ten, $10,000 was again drawn from the bank and the year-end cash value of the policy was $110,000. From year eleven onwards, the policy would be paid up and no amount would be drawn on the bank. However, accounting entries could still be made based on the change in cash value over the fiscal period.
In order to enhance the value of information provided by a company’s financial statements, notes are usually added to explain significant accounting policies and other information on the financial statements. The actual cash value of the corporate-owned life insurance policy as well as the death benefit and other pertinent information could be disclosed in a note to the financial statements. This will ensure that the policy has been properly accounted for and important information is available to the readers of the financial statements.
Accounting is very important because it reports the performance of the company to various interested parties. Accounting is based on conservative rules that are applied consistently over time. While not an end in itself, it is still important to be able to know how to record the purchase of corporate-owned life insurance.
E.O. & E.
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Copywrite ISSN 0382-7038
Contributors to this edition:
James W. Kraft, cpa, ca, mtax, tep, cfp, clu, ch.f.c.
Deborah Kraft, mtax, tep, cfp, clu, ch.f.c.