Like most business owners, you probably agree that your business has a need for life insurance protection. It can provide for business needs like key person coverage, covering capital gains tax liabilities or buy/sell funding. In addition to the life insurance protection provided, such policies may also accumulate significant cash values.

Within limits set by legislation, values in certain life insurance policies accumulate on a tax-deferred basis. Depending on the amount of insurance purchased, there is the potential to build a great deal of value within the policy while the growth in the plan remains exempt from annual taxation.

The accumulated value in the exempt policy is a corporate asset. Either the corporation or a shareholder may borrow money from a bank using the corporate-owned life insurance policy as collateral security. Tax consequences will vary depending on the structure of the arrangement.

Loan proceeds generate a cash flow that may be applied in a number of ways, including supplementing your retirement income, buying out a retiring shareholder, or a variety of other applications depending on the structure.

The adage "you have to have money to make money" has held true for many years. Whether your goal is global expansion or simply the purchase of additional inventory when cash reserves are not sufficient to drive the project, lending institutions are often your first stop. However, when embarking on the project, the would-be borrower should keep in mind that one of the most difficult events for a business to survive is the death of the firm's owner.

Owners are vital to their businesses and the loss of an owner could seriously harm the stability, cash flow and reputation of the company. In order to protect itself, the lending institution often requires life insurance to be placed on the owner(s) to ensure the loan will be repaid in the event of death. Since this is a cost of doing business, all or a portion of life insurance premiums paid by the business may be tax deductible.

The requirements for obtaining a deduction are as follows:

• the loan must be for the purpose of earning income;
• insurance must be required by the lending institution;
• the insurance must be assigned to the lending institution; and,
• the lender must be a restricted financial institution (bank, trust company, credit union or insurance company).