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Disability Buy Out Insurance

  This type of disability insurance is designed specifically to provide the company's owners with the money they would need to reimburse a disabled owner for his or her financial interest in the company. This money is, of course, available over and above any replacement income the owner or partner is receiving under a traditional disability income insurance contract.

How It Works

Setting up the agreement  The Role of Individual DI

If disability insurance for the owners is already in place, the disabled party will begin to receive income after the
policy's waiting period has expired. During that period, the company agrees to continue to pay the disabled owner's salary. When benefits begin, the firm is able to reduce salary payments because of the benefits. Therefore, the disabled owner continues to receive the equivalent of his or her normal pay, but the firm is relieved of part of the financial burden.

Setting up the agreement

      The Buy-Out Options

In the case of prolonged disability (more than a year), most
buy-out agreements take one of the following approaches:

      The Do Nothing Approach Is  Highly Risky

Since the odds indicate that a long-term disability often terminates in death, some businesses choose to play a waiting game, which would ultimately be resolved by a life insurance buy-out at the death of the partner. However, if the owner does not die but remains disabled for years, the costs of paying his or her salary while doing without or having to pay to replace the missing owner's services—can be ruinous to the company.

Readjustment of Ownership Rights Some Pros and Cons   

Here the disabled owner's position is modified usually to limited partner status or he or she is issued preferred, non-voting stock. This gives the disabled party a fixed return on any initial investment but does not allow access to that capital. At the same time, this arrangement relieves the firm of the burden of having to include the disabled owner in day-to-day business decisions.

Mandatory Purchase A Better Way

This alternative calls for the firm (entity purchase) or the other owners (cross purchase) to purchase the entire interest of the disabled owner for a price agreed upon in advance and funded by the company's Disability Buy-Out insurance. Ownership is then transferred at once, with the money paid either in a lump sum, in installments or a combination of these two methods.

Tax Considerations

Premiums paid for disability buy-out policies are never deductible, whether paid by corporations, partnerships or individuals. Correspondingly, the premiums are not considered taxable income to the insureds.

In executing the terms of a buy-out agreement, payments are
considered a capital transaction and are therefore not tax-deductible. Benefits received by the owner/beneficiary are free of income taxes. However, payments made to the disabled party under the terms of the buy-out agreement are taxed as a capital transaction.

If the buy-out proceeds are received in a single sum, the
entire gain will be taxed that year. If, on the other hand, the sale price is to be paid over a number of years, any gain will be taxed over that period of years rather than in a single year. The payments each year are considered a combination of "return of capital," which is not taxable, and capital gain and interest, which are taxable.

Related Topics
                Business Disability Products   
  Professional Business Disability Overhead Expense
                  Disability Buy Out  
                  Disability Buy Out Insurance
                  Keyman Disability insurance  
                  OTHER PROFESSIONALS
  Employer Groups

Not all insurance products from all insurance companies are available in all states.

Note:  We do not provide legal or tax advice. The general information presented on various tax aspects contained in this site are not intended to be relied upon as tax advice. Individuals should seek the advice of a qualified tax professional regarding the taxation of these benefits as they apply to your particular situation.  These benefits are offered in all states except: AK, HI, & WY. License #'s: CA: OC38446 MT: 29724 F00-0283-LC 

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