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Q: My husband owns a numbered corporation with some passive income, which was a professional corporation until his retirement 12 years ago. The corporation is the owner as well as the beneficiary of a universal life insurance policy. We would like to get some advice on the distribution of the amount from the corporation to our sons, who live in Canada, and our daughter and grandchildren, who are U.S. citizens and residents.
We asked Jason Heath, CFP, managing director at Objective Financial Partners Inc., to answer this one.
Assuming the life insurance is on your husband, when he passes away, the corporation will receive the death benefit tax‑free, Mr. Heath said. The amount of the death benefit that exceeds the policy’s adjusted cost base will be credited to the corporation’s notional capital dividend account (CDA).
According to the Canada Revenue Agency, the CDA keeps track of various tax-free surpluses accumulated by a private corporation. These surpluses may be distributed tax-free in the form of capital dividends to the corporation’s Canadian-resident shareholders.
“The CDA balance from the death benefit enables the corporation to then pay out capital dividends to Canadian resident shareholders on a tax‑free basis,” Mr. Heath explained. “This is a valuable estate and tax outcome from corporately owned life insurance.”
I’m thinking of retiring and moving to the East Coast. What are the pros and cons?
Unfortunately, U.S. tax law does not recognize Canada’s CDA system, he noted, meaning your American daughter will generally be required to report any capital dividends as taxable dividend income on her U.S. tax returns. Withholding tax will also generally apply on the payment of dividends to a non-resident, with a credit for foreign tax on their U.S. returns.
According to Mr. Heath, if your U.S. beneficiaries ever become shareholders of the Canadian corporation, they may become subject to extensive U.S. reporting obligations. “These compliance obligations may be a reason to avoid transferring shares during your life or upon your death to a U.S. person,” he advised.
If your husband dies before you, and the life insurance policy is on him, you may be able to pay out the tax-free capital dividend to yourself and avoid this non-resident tax issue. If the policy is on both of you (joint last to die, for example), or he dies after you, there may still be options.
“For example, your executors may decide to pay out tax-free capital dividends to the Canadian resident estate or to your Canadian resident sons and exclude your daughter. She can potentially be made whole instead using other estate assets,” Mr. Heath said.
It’s important to note that estate beneficiaries do not necessarily need to receive an equal share of every single asset within an estate, so there may be some flexibility. “Your situation is complicated. You should seek legal and tax advice to make sure your goals after your death are well taken care of before you die.”
Do you want advice on a financial planning or retirement issue that’s affecting you? Send us an e-mail.
