Unfortunately, most Canadians can’t claim life insurance premiums on their taxes. However, premiums are tax-deductible in certain situations.
To determine when business owners can deduct premiums and which collateral rules apply, we reviewed the Canada Revenue Agency’s business-insurance expense guide, paragraph 20(1)(e.2) of the Income Tax Act, the CRA’s employer-premium and benefit chart, and the CRA’s capital-dividend guidance.
Is Life Insurance Tax-Deductible in Canada?
Life insurance premiums are generally not deductible as personal or business expenses. An individual can’t claim a deduction for premiums on their own life insurance policy because they’re considered personal expenses.
Similarly, a corporation generally can’t claim a deduction simply because it owns the policy, pays the premiums or is the beneficiary.
A tax deduction lowers taxable income. Life insurance death benefits are also generally not subject to income tax. However, just because death benefits are usually received income-tax-free does not mean premiums are deductible.
An exception may apply when a taxpayer uses a life insurance policy as collateral to secure a loan. Premiums may be deductible in respect of certain business and investment loans. Separate rules apply to premiums payable under a group life insurance policy offered by an employer.
When Is Life Insurance Tax-Deductible?
There is a very limited exception under paragraph 20(1)(e.2). The exception allows a taxpayer who assigns an interest in a life insurance policy, as collateral, to a restricted financial institution as a condition of borrowing to deduct premiums on the life insurance policy.
For example, a life insurance policy assigned to a financial institution to secure a line of credit, as confirmed by the financial institution, may qualify for a deduction, subject to the limits below. The interest on the line of credit must also be deductible under the borrowing-to-earn-income rules of the Income Tax Act.
Simply assigning a life insurance policy does not make premiums deductible. For example, where borrowed money is used to purchase personal items or the interest on the loan is not deductible, premiums paid on a life insurance policy assigned to secure the loan would not be deductible.
Meeting the above criteria does not mean that all premiums paid during the year are deductible. The deductible amount is limited to the premiums paid. The calculation also involves the net cost of pure insurance, or NCPI. The NCPI is a specific calculation under the Act and is not the same as the premiums paid. The amount is further limited to the portion of NCPI reasonably considered to relate to the debt during the year.
Given the limited circumstances where premiums may be deductible, confirm with your lender whether life insurance was a condition of borrowing. Contact your insurer to obtain the NCPI amounts and ask your accountant each year to confirm that the borrowing still qualifies and to perform the calculation.
Employer-Paid Group Life Insurance
Life insurance premiums paid by a business for group life insurance are not necessarily deductible simply because employees or their families are beneficiaries. Premiums may be deductible if they qualify as reasonable benefits for employees. Plans for shareholders or other related persons should be reviewed separately.
The CRA generally considers an employer’s contribution to a group life insurance plan to be a taxable benefit to the employee. Payroll requirements may apply even if the benefit is not paid to the employee in cash.
Whether a business can deduct the cost of life insurance for its employees and whether employees must include a taxable benefit are separate questions.
Read More: Read Whether Life Insurance Is Taxable in Canada
Corporate-Owned Life Insurance and the Capital Dividend Account
CRA rules allow life insurance proceeds received by a private corporation, minus the adjusted cost basis of the policy immediately before the insured’s death, to be added to its capital dividend account.
Paying a capital dividend requires an appropriate amount in the capital dividend account and a capital-dividend election. This does not happen automatically. The corporation must also avoid making an election for more than it is entitled to, which can result in a penalty known as Part III tax.
Owners of corporations should work with their accountants and legal advisers to determine how to own the life insurance, designate beneficiaries, calculate the policy’s adjusted cost basis and pay amounts to shareholders.
Read More: See How Corporate-Owned Life Insurance Works
Do Provincial Rules Change the Tax Treatment?
Each province has its own premium taxes, insurance, family law and estate rules. These differences may affect the best ownership structure, the choice of beneficiary and the cost of the policy.
However, provincial laws do not change the federal income-tax rules governing the deductibility of premiums. Personal life insurance premiums are generally not deductible under those rules.
Questions to Take to Your Accountant and Insurer
This list provides general information and is not a substitute for professional tax or legal advice. A qualified professional should review transactions, elections, calculations, policy changes and tax filings.
Below are some of the questions you should ask your accountant and insurer:
- Who are the parties: the owner, payor, insured person and beneficiary?
- Is this a corporate-owned policy? Are amounts being tracked in the capital dividend account?
- What are the current and future NCPI, adjusted cost basis, premiums and loan or withdrawal balances? Who is responsible for these calculations?
- For loans, surrenders, transfers or withdrawals, could there be a taxable gain? Where will the funds be used?
- For lending situations, must the policy be assigned? Is the lender a restricted financial institution?
- If an election is required, who will prepare and file it?
Read More: Read How Key Person Insurance Works for a Business