Life insurance is a valuable asset for charitable giving because it allows a donor to make a charitable bequest without depleting the donor’s estate assets. It also provides the opportunity to magnify the size of a charitable gift.
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All too often, we tend to think of charitable giving with life insurance from an individual’s perspective. This type of giving can, however, be accomplished when life insurance is owned by a corporation. Why would a corporation want to complete a charitable gift?
Individual shareholders might cause their corporation to complete a charitable donation because the corporation has the capital necessary to complete the gift. Alternately, the corporation might be a central entity within a family unit and a gift from the corporation would address the family’s planning objectives.
The following are a few examples of how charitable giving with corporate-owned life insurance might be accomplished.
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Gift of the Life Insurance Policy
A corporation could gift a new or existing life insurance policy. Generally, the gift of the life insurance policy results in a charitable gift being recognized for an amount equal to the fair market value of the policy. There are, however, two exceptions to this rule of thumb
– if the policy was acquired in the last three years, or if it
was acquired within the last 10 years and it is reasonable
to conclude that one of the main purposes for acquiring
the property was charitable giving.
Falling within one of these two exceptions means the value of the charitable gift is recognized at the policy’s adjusted cost basis. A policy’s adjusted cost basis is available from the insurance carrier. Determining the fair market value of an existing policy can be complex and typically should be established by a qualified professional who will consider information specific to the policy.
Consider the example of Paul who owns 100 percent of PQR Company Limited (PQR), which owns a life insurance policy on Paul’s life. The policy was acquired nine years ago for the purpose of securing a term loan incurred by the company. PQR no longer requires the insurance for its original purpose and Paul feels that his estate plan is sufficiently balanced without this
policy. As such, he sees the policy as an ideal asset for charitable giving and has decided to have PQR gift the
policy to his favorite charity.
Recall that PQR acquired the policy more than three years ago and its original purpose was not for charitable
giving. Therefore, the value of the policy for purposes of the charitable receipt should be the fair market value of the policy. If Paul’s health has changed or the policy has a fixed cost (sometimes referred to as level cost), the fair market value could be higher than the policy’s cash surrender value.
From PQR’s perspective, the company has disposed of the policy for deemed proceeds equal to the greater of the:
(1) cash surrender value of the policy;
(2) adjusted cost basis of the policy; and,
(3) fair market value of any consideration received on
In a gifting situation, there is usually no consideration, so deemed proceeds will be the greater of cash surrender value (number one above) and adjusted cost basis (number two above). Note that PQR’s deemed proceeds are not linked to the amount of the charitable receipt, which should be issued for the policy’s fair market value.If premium payments associated with the policy are
If premium payments associated with the policy are to be continued after the donation, the charity can issue a charitable receipt to PQR for any payments the corporation makes subsequent to the charity’s assumption of ownership.
There is no charitable receipt issued upon Paul’s (the life insured’s) death under the strategy discussed above because receipts were issued during his lifetime and the charity is the owner of the policy at the time of Paul’s death. It should be noted that corporate gifts qualify for a tax deduction rather than a tax credit as is the case with individual donations.
Gift of the Life Insurance Benefit
An alternative when utilizing life insurance for charitable purposes is to donate the death benefit associated with the policy. Under this strategy, the charitable receipt arises at the time of the life insured’s death. Planning with a corporate-owned life insurance policy under this strategy is more complex. The charity should not be named as the beneficiary of the policy.
Why? There is no donation receipt available and the corporation is not entitled to a credit to its capital dividend account when the life insurance proceeds are paid. In addition, there is the potential the CRA may assess a shareholder benefit depending upon the circumstances.
Instead, a charitable gift could be achieved by having
(a) shareholder’s will instruct the executor to cause
the company to make the charitable gift upon the
death of the life insured;
(b) company pay a capital dividend to the
shareholder’s estate, who would then make the
donation pursuant to the will and become the
recipient of the charitable receipt; or,
(c) deceased’s estate donates fixed-value preferred
shares of the company to the charity and has
the company use the life insurance proceeds to
purchase (redeem) the shares from the charity.
In (a) above, the company makes the gift and can claim a tax deduction for the amount of the gift, but with the limitation that the deduction cannot exceed 75 percent of the corporation’s net income. Any portion of the gift made but not claimed because of the 75 percent limitation, or because the corporation opts not to claim an eligible amount, can be carried forward and claimed in any of the five subsequent taxation years of the corporation.In (b) and (c) above, the claim for the charitable tax
In (b) and (c) above, the claim for the charitable tax credit will depend on whether the gift was completed from the Graduated Rate Estate (GRE) of the deceased. A gift completed through the GRE can be claimed on the deceased’s terminal tax return, the deceased’s tax return from the year prior to death, or any prior tax return of the GRE. A gift made from a testamentary trust that is not a GRE can be claimed only in the year the gift is made or in any of the five subsequent years.
Charitable gift planning entails looking at the individual’s overall situation and creating a charitable strategy
that best fits the circumstances. Corporate-owned life insurance should not be overlooked for charitable gift planning, but care should be observed to ensure the arrangements do not inadvertently create an unintended consequence.
This commentary is published by the Institute in consultation with an editorial board comprised of recognized authorities in the fields of law, life insurance and estate administration.
The Institute is the professional organization that administers and promotes the CLU and the CHS designations in Canada.
The articles and comments are not intended to provide legal, accounting or other device in individual circumstances. Seek professional assistance before acting upon information included in this publication.
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Copyright 2017 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.