An existing tax debt at the time of death can wreak havoc on the administration of an estate and can jeopardize the estate and insurance planning. This is because the Canada Revenue Agency (“CRA“) is not your typical creditor and has statutory powers to seize assets of the estate beyond what other creditors may seize.

Personal Insurance

If the insurance proceeds are payable to the designated beneficiary(ies) under the insurance policy, the CRA would not seize the proceeds to cover a tax debt. This is based on the rationale that the insurance proceeds were never transferred [emphasis] to the beneficiary(ies); it was paid out to the beneficiaries in accordance with a contractual obligation.

On the other hand, if the proceeds of insurance are payable to the estate, it forms part of the residue of the estate and is subject to creditors’ claims, most notably the CRA.  Further, the executor must know that the CRA may have a super priority (with some exceptions) over other creditors thus, the tax debt must be addressed in priority and the proceeds of insurance are likely at play.

What about corporately-held insurance?

Proceeds of corporately-held insurance payable to the corporation on the death of a shareholder may be subject to claim by the CRA for the corporation’s tax debt.  This can be problematic to the estate in the context of a buy-sell agreement on a shareholder’s death where the insurance proceeds are to be used to repurchase the shares of the deceased. This can be a challenging situation for the surviving shareholders and the deceased’s estate; the funds may not be available for the purchase of the shares.

A U.S. Tax Debt …

Similarly, the Internal Revenue Service (IRS) may seize life insurance proceeds if the insured failed to name a designated beneficiary(ies) or names a minor beneficiary(ies). For a Canadian taxpayer with an existing U.S. tax debt, this is also relevant.

In the context of a cross-border tax debt, one must consider Ryckman v. Commissioner. In that decision, the IRS was required, under the Canada-U.S. Income tax Treaty, to collect a Canadian tax liability and the taxpayer had no right to appeal the validity of the tax debt. In other words, if the Canadian tax debt is confirmed, the IRS must collect.

Applying the same reasoning in the context of a U.S. tax debt, one may assume the proceeds of insurance payable to a Canadian estate may be claimed by the IRS to repay a U.S. tax debt with little recourse available to the estate.

Conclusion

Estate advisors very rarely enquire with their client as to whether there is a lingering tax debt. However, if insurance is a key component of the client’s estate plan, one may want to ask about an existing tax debt as it may alter the insurance planning.

Insurance plays a key role in safeguarding wealth and providing for loved ones. Proper planning is key but open and transparent discussions between the client and his advisor are paramount. In other words, if there is an existing tax debt, we need to know.