Corporate-Owned Life Insurance and the CDA | LLQP Tax Rules Guide

Why corporations own life insurance

For an incorporated business owner, holding permanent life insurance inside the corporation is a staple planning structure. The reasons tested on the LLQP:

• Premiums are paid with corporate dollars, taxed at the small-business rate rather than the owner's personal marginal rate — fewer pre-tax dollars needed per premium dollar.
• The death benefit can fund buy-sell agreements, cover a key person, or repay corporate debt.
• At death, the policy's value can flow to the family or shareholders largely tax-free through the capital dividend account (CDA).

The exam expects you to know both layers: how the policy is taxed (same ACB and exempt-test rules as personal policies) and how the corporation and shareholders are taxed when money moves.

Premiums: not deductible

The foundational rule: life insurance premiums are generally not a deductible expense for the corporation. They are paid with after-tax corporate income. The exam will offer "the corporation deducts the premium as a business expense" as a tempting wrong answer — reject it.

A narrow exception exists: when a lender requires a life insurance policy as collateral for a business loan, a limited deduction of the lesser of the premium or the net cost of pure insurance may be allowed, if other conditions are met. Know it exists; know it is the exception.

During the policy's life

• The corporation is owner and (usually) beneficiary.
• If the policy is exempt, growth compounds tax-sheltered inside the policy — same exempt test rules as personal policies.
• Surrenders, withdrawals and policy loans produce taxable policy gains to the corporation using the same ACB mechanics as individuals — see accrual taxation and universal life.
• Key person insurance: premiums still not deductible; the death benefit is received tax-free by the corporation and is not taxable income to it.

The capital dividend account (CDA): the star of this topic

The CDA is a notional tax account — it does not hold money. It tracks amounts a private corporation can distribute to shareholders as tax-free capital dividends. Ordinary dividends are taxable to shareholders; capital dividends are not. That asymmetry is the whole point.

The CDA credit from life insurance, at the insured's death:

• CDA credit = death benefit received minus the policy's ACB immediately before death.

Because ACB typically declines over time and often reaches zero, in a mature policy the entire death benefit frequently credits the CDA.

Worked example

Dubois Holdings Inc. owns a whole life policy on the founder's life:

• Death benefit: $1,000,000
• ACB at death: $150,000

At death:

1. The corporation receives $1,000,000 tax-free — a life insurance death benefit is not income.
2. CDA credit: $1,000,000 − $150,000 = $850,000.
3. The board declares a capital dividend of $850,000 to the estate/shareholders — received tax-free.
4. The remaining $150,000 (the ACB portion) can be paid out as a taxable dividend, or retained.

Exam trap: candidates who forget to subtract ACB answer that the full $1,000,000 credits the CDA; candidates who forget the CDA entirely think the family receives a taxable dividend. Both wrong.

The disposition rule most students miss

When a corporation owns the policy, moving it in or out of the corporation is a disposition:

• Transferring a personally owned policy to a corporation, or a corporate policy to a shareholder, is generally treated as a disposition at the policy's value — potentially triggering a policy gain to the transferor, and in the shareholder direction possibly a shareholder benefit.
• Roll-over relief exists in narrow cases (e.g., certain transfers to a spouse), but corporate transfers are a classic "gotcha" scenario: moving an old policy with low ACB out of the corporation can create a large taxable gain.

Common exam scenarios, decoded

• "Corporation pays premiums on a policy covering the owner-manager, corporation is beneficiary." Premiums non-deductible; death benefit tax-free; CDA credit = benefit − ACB; capital dividend to the estate is tax-free.
• "Bank requires life insurance as loan collateral." Possible limited premium deduction; also review collateral loans — the assignment itself triggers no tax.
• "Holding company owns the policy; operating company needs the funds." A red flag that inter-corporate dividends or CDA planning is being tested.
• "Shareholder personally owns the policy but the corporation pays the premium." A taxable shareholder benefit issue — poor structure, and the exam rewards spotting it.

Quick reference table

The ACB subtraction in the CDA formula is where most errors happen, so make sure the mechanics in adjusted cost basis (ACB) explained are second nature — and keep the whole map in view at the Life Insurance Taxation hub.