BUSINESS LIFE INSURANCE (Chapter 8)

Question 1

REVIEW

Name Two ways to identify the risk of death

Answer 1

• Life expectancy
• Probability rate

Question 2

REVIEW

What are some Key Points for Level Death Benefit + Account Value?

Answer 2

• Net Amount at risk (NAAR) remains level over time.
• Mortality deductions are greater than Level Death Benefit.
• Investment account grows more slowly.
• Beneficiary receives original amount of insurance, plus the full account value, as a tax-free death benefit.
• Suitable for those who deposit large premiums in excess of the
  amount required.

Question 3

REVIEW

The insurance contract usually places limits on the PUA rider, name some.

Answer 3

The Limits are;

• The minimum PUA that can be purchased at any one time.
• The maximum PUAs that can be purchased in any one year.
• The cumulative maximum PUAs that can be purchased over the life of the policy.
• When the policyholder can purchase PUAs (Ex. on policy anniversary.)
• The maximum age of the life insured at the time of purchase.

Question 4

REVIEW

Name the 4 Riders in UL or Whole Life that provide additional benefits upon death

Answer 4

1. Paid-up additions (PUA) rider
2. Term insurance riders
3. Accidental death (AD) rider
4. Guaranteed insurability benefit (GIB) rider

Question 5

REVIEW

What are the calculations for a policy withdrawal?

Answer 5

FA = $200,000
ACB = $65,000
CSV = $80,000

1. Amount withdrawn / CSV x ACB = Prorated ACB
   (($40,000 / $80,000) x $6500) = $32,500
2. Amount withdrawn — Prorated ACB = Policy Gain
   $40,000 —32,500 = $7500
3. Policy Gain x MTR = Tax Payable
   $7,500 x 35% = $2,625
4. Policy Gain — Tax Payable = After Tax Funds
   $7,500 — $2,625 = $2875

[Ref. 7.4.2]

Question 6

REVIEW

Explain the Term Insurance under the Dividend Payment Option.

Answer 6

• Policy dividend is used as a single premium to buy one-year term insurance.
• No proof of insurability required.
• The amount of term insurance depends on the size of the dividend.

Question 7

REVIEW

Explain Income Attribution Rule

Answer 7

Taxable income to the transferor spouse even if it is earned and legally belongs to the recipient spouse. Once the transferor spouse dies, the income attribution rules cease to apply.

• (i.e., Noah recently assigned a life insurance policy with a CSV of $85,000 and an ACB of $32,000 to his wife, Eve.
• Suppose that Noah did not opt out of the automatic rollover, and that Eve later surrendered the policy when its CSV was $94,000. As a result of the income
  attribution rules, Noah would have to report the resulting policy gain of $62,000.(Policy gain = $94,000 – $32,000 = $62,000)

[Ref. 7.8.3.2]

Question 8

REVIEW

What are the premium deduction calculations for a business expense on a collateral assignment?

Answer 8

Face Amount ÷ Loan Amount = Percentage%
($500,000 / $200,000 = 40%)

Percentage x NCPI = Deduction
(40% × $3,200 = $1,280)

(Deduction as a business expense)

Question 9

REVIEW

Potential Financial Impact of Death (6)

Answer 9

1. Loss of Income
2. Loss of Caregiver
3. Debt Repayment
4. Income Taxes
5. Estate Creation (Education funds, Legacies, Charitable Giving)
6. Business Impacts

Question 10

Life Insurance Terminology

Lifetime Capital Gains Exemption (LCGE)

Answer 10

An Important tax attribute of a Canadian Controlled Private Corporation (CCPC) where a taxpayer can use this attribute to eliminate or offset capital gains.

Question 11

Life Insurance Terminology

Probate

Answer 11

The general administration of a deceased person’s will or the estate of a deceased person without a will.

Question 12

Life Insurance Terminology

Capital Gain

Answer 12

A profit from the sale of property or an investment.

Question 13

Life Insurance Terminology

Promissory Note

Answer 13

A signed document containing a written promise to pay a stated sum to a specified person.

Question 14

Life Insurance Terminology

Canadian-Controlled Private Corporations (CCPC)

Answer 14

Private corporation with specific characteristics that enables tax-advantages.

Question 15

Life Insurance Terminology

Fair Market Value (FMV)

Answer 15

An asset’s estimated value if it were sold today in the current market.

Question 16

Life Insurance Terminology

The difference between Adjusted Cost BASE
& Adjusted Cost BASIS

Answer 16

Adjusted Cost BASE
- Deemed Disposition of capital property such as a rental property or company shares.

Adjusted Cost BASIS
- Amount of money invested in an insurance policy, and the calculation of the policy gain.

Question 17

Chapter 8 - Business life insurance

Businesses may use life insurance to accomplish a number of different objectives, Name some.

Answer 17

• Protecting the business from the death of a key employee or shareholder;
• Funding a buy-sell agreement;
• Providing additional compensation for highly valued employees.

Question 18

Name some Potential Impact of death on a business (5)

Answer 18

• Loss of skills;
• Creditor demands;
• Family interference;
• Equality for family members;
• Capital gains tax.

Question 19

What is a key-person employee?

Answer 19

An Individual or persons who are integral (essential) to the success of the business;

(For Example)

• A highly skilled craftsman;
• An entrepreneurial genius;
• An influential vice-president;
• A charismatic salesperson;
• An engineer with a particular expertise for the running of a factory.

Question 20

Business Insurance

Simplify the term Creditor Demand

Answer 20

• The nature of urgently paying back a loan the to bank institution.
• (Example) If a business has significant debt and a key person dies, creditors can become nervous and may recall demand loans or refuse to extend additional credit if the company needs it.

Question 21

Chapter 8 - Business life insurance

Explain the term family member interference

Answer 21

The problems that may arise if the deceased of a business corporation leaves his interest in the business to his surviving spouse or children.

Question 22

Illustrate a scenario where family member interference apply

Answer 22

Jason, Ivan and Conner were the joint owners of Restful Solutions, a funeral home that caters to the upper class of society.

Jason died without a will and he was survived only by Mason, his 24-year-old son.

Mason is a troubled young adult with a history of petty theft and drug use.

Mason inherited Jason’s ownership interest in Restful Solutions. He showed up drunk at the funeral home shortly after his father’s death and loudly announced his intention to take over his father’s role in the business.

When Ivan and Conner tried to tell him that it was not a suitable role for him, he demanded $1,200,000 for his share in the business.

[Ref. 8.1.3]

Question 23

Chapter 8 - Business life insurance

How can we avoid the problems that may arise with Family member interference?

Answer 23

Buy-Sell Agreements (Business insurance)

Question 24

What is capital gains tax?

Answer 24

When a taxpayer is deemed to have disposed of all of his property for its fair market value immediately prior to death (unless a spousal rollover applies).

Question 25

Chapter 8 - Business life insurance

There are 3 types of business’, what are they?

Answer 25

• Sole proprietorship;
• Partnerships;
• Corporations.

Question 26

Simplify Sole Proprietor

Answer 26

Unincorporated business that is owned by a single person.

Question 27

Simplify Partnership

Answer 27

Business that is owned by two or more people who have the common purpose of
earning a profit.

Question 28

TRUE OR FALSE?

A limited partner is entitled to shares
in the partnership’s profits, but is not personally responsible for the business’s debts or other obligations.

Answer 28

TRUE

[Ref.8.2.2]

Question 29

TRUE OR FALSE?

A limited partnership don’t require general partners. The limited partners also liable for the business’ debts and obligations.

Answer 29

FALSE

A limited partnership must always have at least one general partner, who is personally liable for the business’s debts and obligations.

[Ref.8.2.2]

Question 30

TRUE OR FALSE?

Unlike a sole proprietorship, a partnership interest can be bought, sold or bequeathed upon death.

Answer 30

TRUE

[Ref.8.2.2]

Question 31

Simplify Incorporated business

Answer 31

Legal entity that is separate and distinct from its owners (shareholders).

Question 32

TRUE OR FALSE?

The corporation’s shareholders must report the company’s net income directly on their personal tax returns.

Answer 32

FALSE

The corporation’s shareholders do not report the company’s net income directly on their personal tax returns; instead, that net income is taxed in the corporation.

[Ref.8.2.3]

Question 33

Chapter 8 - Business life insurance

TRUE OR FALSE?

After-tax profits in a corporation increase the shareholder’s value and are paid out to the corporation in the form of after-tax dollars.

Answer 33

FALSE

After-tax profits either increase the
corporation’s share value or get paid out to the shareholders in the form of dividends.

[Ref.8.2.3]

Question 34

TRUE OR FALSE?

Shares in the corporation have an adjusted cost base. In addition, the sale or deemed disposition upon death can result in capital gains or losses.

Answer 34

TRUE

Question 35

What are some of the characteristics of a Canadian-Controlled-Private Corporations (CCPC)

Answer 35

• It is not listed on a public stock exchange;
• It is resident in Canada;
• It is not controlled, directly or indirectly, by one or more non-resident persons;
• It is not controlled, directly or indirectly, by one or more public corporations.

Question 36

What is the most important tax attribute of Canadian-Controlled-Private Corporations (CCPC) ?

Answer 36

Upon deemed disposition, the shares may be eligible for the lifetime capital gains exemption (LCGE).

The LCGE for a CCPC is $913,630 for 2022 and is indexed annually for inflation.

Question 37

Chapter 8 - Business life insurance

Can a taxpayer use the lifetime capital gains exemption (LCGE) to eliminate or offset capital gains realized upon the disposition of qualified shares in a Candian-Controlled Private Corporation (CCPC)?

Answer 37

YES

The LCGE for a CCPC is $913,630 for 2022 and is indexed annually for inflation.

Question 38

What are the calculations for capital gains tax?

Answer 38

FMV — ACB = Capital Gain
($2,400,000,000 — $200,000,000 = $1,200,000)

Capital Gain x 50% = Tax Liability
(1,2000,000) × 50% = $600,000)

[Ref. 8.2.3.2]

Question 39

Chapter 8 - Business life insurance

Illustrate a scenario where the Lifetime Capital Gains Exemption (LCGE) applies.

Answer 39

• Gene was the sole shareholder of his sportswear manufacturing company, Kiliman, which is a Canadian-Controlled Private Corporation (CCPC).
• When he died, the business had a fair market value (FMV) of $2,400,000 and an adjusted cost base (ACB) of $200,000.
• He left the business to his daughter, Yvonne. This deemed disposition resulted in a capital gain of $2,200,000. (Capital gain = $2,400,000 – $200,000 = $2,200,000)
• Gene has never made use of the LCGE, so $913,630 (in 2022) of this capital gain is exempt from tax, leaving his estate with a taxable capital gain of $643,185. (Taxable capital gain = ($2,200,000 – $913,630) × 50% = $643,185)
• If Gene’s marginal tax rate for the year of death was 45%, this would result in a tax liability of $289,433. (Tax liability with LCGE = $643,185 × 45% = $289,433)
• However, if he had not been able to take advantage of the LCGE, the tax liability would have been $495,000. (Tax liability WITHOUT LCGE = $2,200,000 × 50% × 45% = $495,000
• [Illustrate the numbers and calculations on paper by yourself to understand this concept 100%]

[Ref. 8.2.3.2]

Question 40

Chapter 8 - Business life insurance

If the key person employee dies within an organization, the company would receive the death benefit tax-free and could use it to help the business survive by…

Answer 40

• Recruiting and training a replacement;
• Making up for lost revenue;
• Covering overhead expenses until the company gets back on its feet.

Question 41

Explain the method, split-dollar arrangements

Answer 41

A split-dollar life insurance arrangement is a method of sharing the attributes and costs of a permanent life insurance policy amongst two or more parties.

Question 42

How is the split-dollar arrangement used?

Answer 42

• When more than one party requires the benefits that can be provided by a life insurance policy.
• Also might be used where one party needs life insurance protection, and the other party is looking for a tax-deferred investment vehicle.

Question 43

What’s the most common arrangement for key person insurance?

Answer 43

Split-Dollar Arrangement

• The corporation could own the death benefit up to the original face amount, while the employee owns the policy’s cash value and any death benefit in excess of the original face amount.

[Ref. 8.3.1]

Question 44

TRUE OR FALSE?

In a split-dollar arrangement the corporation pays all premiums.

Answer 44

FALSE

In a split-dollar arrangement the employee and the corporation would split the premiums in a way that recognizes their separate economic interests in the policy.

[Ref. 8.3.1]

Question 45

TRUE OR FALSE?

In the latter case, where the corporation owns the death benefit up to the face amount, its share of the premiums would be tied to the reasonable costs for comparable term insurance coverage, and the employee would receive the balance of the premiums from the plan sponsor of the business.

Answer 45

FALSE

In the latter case, where the corporation owns the death benefit up to the face amount, its share of the premiums would be tied to the reasonable costs for comparable term insurance coverage, and the employee would pay the balance of the premiums.

Question 46

Chapter 8 - Business life insurance

Depending on the fair market value (FMV) of the policy upon upon retirement or termination of employment, the transfer of the death benefit that transfers to the departing employee results in a taxable benefit for the employee.

Answer 46

TRUE

[Ref. 8.3.1]

Question 47

Chapter 8 - Business life insurance

TRUE OR FALSE?

If the success of a business depends on the involvement of a key person, a financial institution extending a loan to that business may require the assignment of a life insurance policy on the corporation.

Answer 47

FALSE

If the success of a business depends on the involvement of a key person, a financial institution extending a loan to that business may require the assignment of a life insurance policy on that key person.

Question 48

Chapter 8 - Business life insurance

What is a buy-sell agreement?

Answer 48

Contract agreement between businesses partnerships or private corporations to control what happens if one of the owners dies.

Question 49

A buy-sell agreement usually specifies some conditions, what are they ?

Answer 49

• Who has the option or the obligation of buying an owner’s interest in the business upon his death;
• The price that will be paid for that ownership interest, either as a fixed dollar amount or as a formula or method to calculate the purchase price;
• How the purchase will be funded.

Question 50

Explain why Buy-sell agreements are important

Answer 50

Buy-sell agreements are important whenever two or more people own a business together.

If one of the business owners dies, a properly funded buy-sell agreement protects the surviving business owners, the business itself, and the surviving family or other beneficiaries of the deceased owner.

Question 51

There are 3 ways to fund a buy-sell agreement, what are they?

Answer 51

• Cross Purchase
• Criss-Cross insurance
• Business owned

Question 52

What is a cross-purchase agreement?

Answer 52

• With a cross-purchase buy-sell agreement, the other owners agree to buy the interest of a deceased owner.
• For a corporation, this means each surviving shareholder now owns a greater number of shares.

Question 53

What is Criss-Cross insurance and when is it used?

Answer 53

• It’s an arrangement, where each party to the buy-sell agreement buys life insurance on the other parties to the agreement, in an amount sufficient to cover their purchase obligation upon that party’s death.
• it’s used often to fund cross-purchase buy-sell agreements

Question 54

FILL IN THE BLANK

Buy-sell agreements provide guaranteed buyer, guaranteed value, mandatory sale, and guaranteed___________.

Answer 54

Guaranteed funding through life insurance

[Ref. 8.4.2.4]

Question 55

There are 5 steps with the criss-cross insurance agreement, Explain them.

Answer 55

Jack and Alfred each own 50% of the 200 shares of Jackal Inc., a frozen dessert company.

• They implemented a buy-sell agreement funded with criss-cross insurance. Jack died shortly thereafter. The overall process would look like this:
• 1. Jack and Alfred pay the premiums for life insurance on each other.
• 2. Jack dies, and his 100 shares transfer to his estate.
• 3. The insurance company pays a tax-free death benefit to Alfred.
• 4. Alfred pays Jack’s estate for his 100 shares.
• 5. Jack’s estate transfers the 100 shares to Alfred, who now owns all 200 shares,
  or 100% of the company.

[Explain this to the prospective clients using your own words and examples]

[Ref. 8.4.3]

Question 56

What is One of the DISADVANTAGES of criss-cross insurance?

Answer 56

There may be significant differences in
the premiums for the coverage required on each party, depending on their age and health.

Question 57

Chapter 8 - Business life insurance

TRUE OR FALSE?

The premiums on criss-cross insurance funded with a buy-sell agreement for a business are deductible expenses.

Answer 57

FALSE

Because the insurance is not being used to secure a loan for business or investment purposes, the premiums are not deductible to either the associates or the business. However, the death benefit is tax-free.

[Ref. 8.4.3]

Question 58

Simplify business owned-insurance

Answer 58

Another option for funding the buy-sell agreement which has the business buy the insurance coverage on the business owners.

Question 59

TRUE OR FALSE?

Business-owned insurance can be used to fund both cross-purchase buy-sell agreements and share redemption plans.

Answer 59

TRUE

Question 60

What is a Capital Dividend Account?

Answer 60

An account used by private corporations to record various amounts that it receives on a tax-free basis. (such as the tax-free 50% of capital gains and some or all of the death benefits received from a life insurance policy.)

Question 61

CDA is also known as a…..

Answer 61

Notional Account
- (Which means it does not actually hold funds; it just keeps track of them for tax purposes.)

Question 62

TRUE OR FALSE?

A private corporation that has a CDA can designate a payment to its shareholders as a tax-free capital dividend when it has a positive CDA balance and sufficient cash to do so.

Answer 62

TRUE

A private corporation that has a CDA can elect to designate a payment to its shareholders as a tax-free capital dividend when it has a positive CDA balance and sufficient cash to do so.

• When the corporation pays out a capital dividend, the CDA balance is reduced by the same amount.

[Ref. 8.4.4.1]

Question 63

FILL IN THE BLANK

If a cross-purchase agreement is funded by corporate-owned insurance, usually the corporation is named as the________ of the policy.

a) Beneficiary
b) Policyholder
c) Life insured
d) Successor policyholder

Answer 63

If a cross-purchase agreement is funded by corporate-owned insurance, usually the corporation is named as the beneficiary of the policy.

[Ref.8.4.4.2]

Question 64

FILL IN THE BLANK

When a cross-purchase agreement is funded by corporate-owned insurance and one of the shareholders dies, the surviving owner(s)
purchase the shares from his estate, often using a ___________.

a) Capital Dividend Account CDA
b) Exemption policy
c) Life Time Capital Gains Exemption (LCGE)
d) Promissory note

Answer 64

When a cross-purchase agreement is funded by corporate-owned insurance and one of the shareholders dies, the surviving owner(s)
purchase the shares from his estate, often using a promissory note.

• The insurance company will pay the death benefit to the corporation, which will credit the amount to its capital dividend account. (Notional Account)
• The surviving shareholder(s) will then direct the corporation to pay them a capital dividend, which they will use to pay off the promissory note.

[Ref.8.4.4.2]

Question 65

There are 7 steps with the corporate-owned cross-purchase agreement Explain them.

Answer 65

Suppose Jack and Alfred’s cross-purchase agreement is instead funded by insurance owned by Jackal Inc. When Jack died shortly thereafter, the overall process would look like this:

• 1. Jackal Inc. pays the premiums for insurance on both Jack and Alfred.
• 2. Jack dies, and his 100 shares transfer to his estate.
• 3. The insurance company pays the tax-free death benefit to Jackal Inc., which is credited to its CDA.
• 4. Alfred pays Jack’s estate for his 100 shares with a promissory note.
• 5. Jack’s estate transfers the 100 shares to Alfred, who now owns all 200 shares, or 100% of Jackal Inc.
• 6. Alfred instructs Jackal Inc. to pay him a tax-free capital dividend.
• 7. Alfred uses these funds to pay off the promissory note.

[Explain this to the prospective clients using your own words and examples]

[Ref. 8.4.4.3]

Question 66

What is a share-redemption buy-sell agreement and how does it work?

Answer 66

• In the case of a share redemption plan, the company and the shareholders are all parties to the buy-sell agreement.
• The company buys life insurance on all of the shareholders, naming itself as the beneficiary.
• When one of the owners dies, the company uses the death benefit to redeem the shares from the deceased shareholder’s estate.

Question 67

There are 5 steps in Funding share-redemption buy-sell agreement Explain them.

Answer 67

• 1. Jackal Inc. pays the premiums for insurance on both Jack and Alfred.
• 2. Jack dies, and his shares transfer to his estate.
• 3. The insurance company pays the tax-free death benefit to Jackal Inc., which
  is credited to its CDA.
• 4. Jackal Inc. uses the funds to redeem the shares from Jack’s estate, cancelling
  the said shares, reducing the number of shares outstanding to 100.
• 5. Alfred still owns the remaining 100 shares, which represents 100% of the company.

[Explain this to the prospective clients using your own words and examples]

[Ref. 8.4.4.3]