When a corporation receives a death benefit from a life insurance policy, how is it taxed?

Proceeds received by a corporation as a death benefit from a life insurance policy under which the corporation is a beneficiary are not taxable to the corporation. If the corporation is a private corporation resident in Canada, in general, the excess of the proceeds received over the adjusted cost basis (“ACB”) of the policy immediately before the time of death is added to the corporation’s capital dividend account (“CDA”).

The ACB of a life insurance policy includes the total of premiums or deposits paid into the policy (including the premium for term riders). The ACB is reduced by the taking of a policy loan, the payment of dividends under a participating policy, and partial dispositions. The ACB is increased by the repayment of a policy loan, the purchase of paid-up insurance, the purchase of term enhancements and policy gains. The ACB is also reduced by the “net cost of pure insurance” relating to the policy. 

Typically, dividends paid by a corporation are taxable dividends. However, if a positive balance exists in the CDA prior to the declaration of the dividend and the directors elect in prescribed manner and form, an otherwise taxable dividend will be a tax free capital dividend to the recipient shareholder(s). In this manner, proceeds received as a death benefit from a life insurance policy by a private corporation resident in Canada can be flowed out to the corporation’s shareholders tax-free.

For more information, see the Tax Topic entitled, “The Capital Dividend Account and Life Insurance”.

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