How a Capital Dividend Is Elected and Paid After a Shareholder Dies

A corporation that receives a life insurance death benefit holds money it can pass to its shareholders without tax in their hands. That ability is not automatic. It rests on a notional account defined in the Income Tax Act, on a figure supplied by the insurer, on a resolution of the directors, and on an election filed with the Canada Revenue Agency on a prescribed form by a stated moment. Miss the moment and the same money still moves, at a cost nobody planned for.

This page sets out the order of those steps so that a family and its professionals can see what has to happen and in what sequence. It recommends nothing and promises nothing. Every tax figure named here belongs to the corporation's accountant, who owns this filing from the first calculation to the last signature, and who is the person to ask before any dividend is declared.

What is the capital dividend account, and where does it exist?

The capital dividend account is a notional account defined at Income Tax Act s.89(1). It records certain amounts a private corporation has received without tax, including the non taxable portion of a capital gain and the credit from a life insurance death benefit. Nothing holds it. It exists in the Act and in the records the corporation keeps.

No deposit account carries the balance. No line of the financial statements reports it. A shareholder reading a year end statement will not find it there, and an accountant who has not tracked it from incorporation forward cannot produce it on demand. The account is cumulative across the whole life of the corporation, so a payment made in one year reduces what remains available in every year after it.

That is the first reason this file belongs to the corporation's accountant. The balance on the day of a death is the product of every transaction that ever touched the account, and reconstructing it after the fact is slow work done under time pressure. A corporation that has kept a running calculation each year arrives at the death with a figure to check. A corporation that has not kept one arrives with a question. The Agency keeps its own record of what the corporation has reported over the years, which is why the corporation's figure and the Agency's figure are both worth having before anything is declared.

What credits the account when a corporation receives a death benefit?

Where a private corporation is the beneficiary and receives a life insurance death benefit, Income Tax Act s.89(1) credits the account with the amount by which the proceeds exceed the adjusted cost basis of the contract immediately before the death. The credit is that excess and never the whole amount payable.

Two conditions sit inside that sentence and both of them get checked. The corporation has to be the party that receives the proceeds, which is a question about the beneficiary designation on the contract and not a question about who paid the premiums. And the adjusted cost basis used is the one that existed immediately before the death, a figure the insurer reports to the corporation once the claim is settled. The insurer produces that figure after settlement, and it belongs in the file in writing.

The arrangement that produces no credit at all is worth naming. Where the contract was owned by a shareholder personally and the proceeds went to a named individual, nothing passed through the corporation and nothing credits the account. Where a corporation owned the contract but designated someone else as beneficiary, the same problem can appear, accompanied by a separate question about a benefit conferred on a shareholder. A corporation named as beneficiary on a contract it does not own raises questions of its own, and those belong to the accountant and the lawyer together. The mechanics of the corporate arrangement are set out on corporate-owned life insurance.

Why does the adjusted cost basis matter, and why does it fall over time?

The adjusted cost basis is the tax cost of the contract, and it sets the size of the credit. Premiums paid add to it. An annual amount representing the cost of the pure insurance is subtracted from it, and that amount grows as the life insured ages, so the basis usually rises early and declines afterwards.

Follow that to its consequence. A contract issued twenty five years before a death has usually seen its basis worn down toward a small figure, so most of the amount payable becomes a credit. A contract issued three years before a death still carries a basis close to the premiums paid, so the credit is smaller by that amount. Two identical amounts payable therefore produce two different credits, and the difference is the age of the contract.

No plan should carry an assumed percentage. The basis moves every year, it moves differently for every contract, and an advance taken against the policy or a withdrawal from it moves the basis again. The insurer can produce a projected basis at future dates on request, and the corporation's accountant can turn that projection into an expected credit. Those two documents, requested while everyone is alive, are worth more than any estimate assembled in the week after a funeral.

What happens between the claim and the dividend?

The claim comes first and the dividend comes last. The corporation notifies the insurer, files the claim with proof of death, receives the proceeds, obtains the adjusted cost basis figure, has its accountant calculate the credit and the resulting account balance, and only then can the directors consider declaring a dividend.

Each step takes real time and the steps do not overlap. An insurer settles a claim on documents, which means a death certificate, a claimant statement, and whatever else the contract requires. The insurer will also want the original contract or a statutory declaration in its place, and that search takes longer in some families than the claim itself. The adjusted cost basis figure often follows the payment by some weeks. A corporation under pressure to move money to a family sometimes wants to declare the dividend on the day the funds land, and declaring before the calculation is finished is where the expensive errors begin.

A decision also hides inside the sequence, and it belongs to the accountant. The corporation does not have to pay out the whole credit at once, and it does not have to pay it in the year of the death. The account carries forward. A single dividend may serve the family better than several, or the reverse may hold, and the answer depends on the corporation's other transactions, on its other shareholders, and on what else the account has to cover.

What paperwork does the election itself require?

Three documents move together. The directors pass a resolution declaring the dividend and authorising the election. The corporation files the election on the prescribed form, Form T2054, under Income Tax Act s.83(2). The form goes in with the schedules the Agency requires, including the calculation of the account balance.

Timing is the part that catches corporations. The election has to be filed on or before the day the dividend becomes payable, and that day is one the directors themselves set in their resolution. A resolution making a dividend payable immediately has set the filing date to the same day. A resolution naming a later date buys the accountant room to finish the schedules and confirm the balance, and choosing that date deliberately is one of the few free moves in this whole procedure.

The certified copy of the resolution goes with the form. So does the account calculation, which has to show how the balance was arrived at and not simply assert a number. The corporation's accountant prepares both and an officer of the corporation signs them. This practice holds an insurance licence and gives no tax advice, and nothing written here replaces the professional who signs that filing. Keep the resolution, the form and the calculation together in one place, because the next person to open that file may be a different accountant in a different decade.

What happens when the election is filed late?

The Act allows a late filed election, and it costs something. The corporation elects under the further subsection of section 83 that permits the late filing, the Canada Revenue Agency assesses a penalty for the delay, and the election is then treated as having been made when it should have been. The dividend itself survives.

The penalty is calculated by formula and this page states no figure for it, because the figure moves with the amount of the dividend and with the length of the delay. The corporation's accountant can compute it before anything is sent. What matters to a family is that a preventable filing error converts part of a payment they were told would be free of tax into a cost, and that the cost is avoided entirely by setting the payable date with the filing in view.

Two further points belong here. A late filed election carries conditions of its own, and those conditions have to be read against the corporation's actual facts before anything is signed. And the remedy narrows with time, so a corporation discovering the problem years afterwards may have fewer moves available than one discovering it in the same quarter. Raise a missed date with the accountant in the week it is found.

What happens if the corporation elects on more than the account holds?

Electing on an amount that exceeds the balance triggers an additional tax on the excess under Part III of the Income Tax Act. That tax falls on the corporation, it is assessed on the excessive part of the election, and it is separate from anything the shareholders are assessed on their own returns.

The Act does provide a route out of part of the problem, and it is an uncomfortable one. A corporation assessed on an excessive election can elect to treat the excess as an ordinary taxable dividend, which removes the additional tax and hands the shareholders a taxable amount they were told they would not receive. That second election has its own conditions and its own consent requirements. The corporation's accountant runs that comparison, and no family should meet it for the first time on an assessment notice.

How does a corporation come to elect on too much? Usually by trusting a balance nobody verified. An old capital gain recorded incorrectly, a capital dividend paid a decade ago by a previous accountant, a portion of a capital loss that was never subtracted: any one of them moves the balance and none of them announces itself. None of those entries is visible from a year end statement, and none of them corrects itself. The balance is the whole of the filing, so the balance is what gets checked.

Why should the balance be confirmed with the Canada Revenue Agency first?

The Canada Revenue Agency will verify a corporation's capital dividend account balance on request, and that request belongs before the election and not after it. Verification compares the corporation's own calculation against the Agency's record of its filing history. A mismatch found before a dividend is declared is a correction. The same mismatch found afterwards is an assessment.

The request goes in on the schedule the Agency publishes for it, and the Agency asks for the corporation's calculation and its supporting detail alongside the request. Turnaround is not instant, which is the working argument for starting the verification while the claim is still being settled. A corporation that waits until the family is asking when the money arrives has put itself in a queue at the worst possible moment.

Verification does not transfer responsibility. The corporation still signs the election and the corporation still carries the additional tax if the election proves excessive, so the Agency's answer is a check on the accountant's work and never a substitute for it. This is the second place on this page where the point has to be made plainly: the corporation's accountant owns this filing. Ask for the verification, read it beside the accountant's own calculation, and reconcile the two before the directors meet.

What is the order of events when the shareholder was also insured?

Two separate matters run on two separate timelines. The shares of the deceased are deemed to have been disposed of immediately before death at fair market value under Income Tax Act s.70(5), which is reported on the deceased's final return. The capital dividend is a corporate filing made later, on the corporation's own timetable.

The sequence carries a wrinkle that repays attention. The value of the shares immediately before death is measured before the corporation receives the proceeds, so the amount payable on the contract may or may not sit inside that value, depending on the facts and on how the shares are valued. That is a valuation question with tax consequences on a personal return, and it is answered by the accountant and, where a dispute is possible, by a business valuator.

The two matters also have different audiences. The deemed disposition concerns the deceased and the estate, and it has a filing deadline of its own on the final return. The capital dividend concerns the corporation and whoever holds its shares when the dividend is declared. Post mortem planning arranges the relationship between the two, and it is specialised work done by a tax accountant with the lawyer or the notary handling the estate. Start that conversation before a death, because several of the available approaches carry timing conditions of their own.

Who can receive a capital dividend, and why does that matter?

A capital dividend is a dividend, so it is paid on shares to whoever holds them when it is declared. The person who died no longer holds shares. If the shares have passed to an estate, the estate receives the dividend. If they have passed to named beneficiaries, those beneficiaries receive it, in the proportions their shares carry.

The consequence is that the shares and the succession documents have to line up. A will leaving the shares to one person while a shareholders agreement obliges the surviving shareholders to buy them creates a question about who holds what on the day of the declaration. A share class carrying no dividend entitlement receives nothing, whatever anyone intended. Declaring before or after a transfer of shares changes who is paid, and that is a choice somebody makes even when nobody notices making it.

This is why a capital dividend cannot be planned inside an insurance conversation alone. The lawyer or the notary who drafted the will and the shareholders agreement, the accountant who will sign the election, and whoever keeps the corporate records all hold a piece of the answer. The wider picture for an incorporated owner is set out across the business owners section. What a Financial Security Advisor contributes is the contract, its adjusted cost basis, and the paperwork the insurer will require at the claim.

What commonly goes wrong?

The recurring failures are few and they repeat. A balance assumed and never verified. A dividend declared payable on the day of the resolution, which leaves no time to file. The whole amount payable treated as the credit, with the adjusted cost basis forgotten. And shares that moved, or failed to move, so the dividend reached the wrong hands.

Two more belong on the list. A corporation that changed accountants at some point in its history and carried no record of the account forward, so the balance has to be rebuilt from old filings. And a beneficiary designation on the contract naming an individual while everyone in the room believed the corporation was named, which removes the credit entirely and can raise a separate question about a benefit conferred on a shareholder. Both failures share one cause, which is that nobody read the documents until the money was already in motion.

Every item above is found by reading four documents before anything happens. The contract and its current beneficiary designation. The corporation's own calculation of the account. The will and the shareholders agreement. And the minute book showing who holds which shares today. A family that can put those four on a table has already avoided most of what goes wrong, and the accountant who owns this filing will ask for all four anyway.

Who this suits, and who it does not

This page suits the directors and the family of a private corporation that has received a death benefit on a contract the corporation owns. It suits an executor or a liquidator handed a corporation with a capital dividend to pay. It suits an owner who wants to know now what will be asked of the corporation later.

It applies with less force where the corporation owns no contract, since nothing credits the account from the source this page describes. It applies with less force again where a single shareholder holds every share and the estate is straightforward, because the recipient question answers itself. Those readers still need the calculation and the filing, and the rest of the sequence is simply shorter for them.

It does not suit a reader who came for a number. No fixed proportion of an amount payable reaches the account as a matter of course, no deadline here is stated in days, and no penalty figure appears anywhere on this page, because each of them depends on facts this page does not hold. Participating whole life insurance is an insurance product and it is not an investment, and nothing written here promises any result to any corporation.

The order to hold is short. Confirm the balance, calculate the credit against the adjusted cost basis immediately before death, set the payable date with the filing in view, pass the resolution, file the election on Form T2054 on time, and keep every document together for the next reader. The corporation's accountant owns that sequence from beginning to end. This practice holds an insurance licence, gives no tax advice and no legal advice, and its contribution stops at the contract and what the insurer requires.