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Disability Buy-Out
Insurance Can Help
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.
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. |
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