Buy-Sell and Disability Arrangements
Buy-Sell Funding Is Not Just For Life
Insurance
For business owners who are prudent enough to
draft and fund a Buy-Sell Agreement that spells out the disposition
of the business at death and provides the resources to carry out
the plan, there is still one more item to be addressed. What happens
in case of disability? Some Buy-Sell Agreements do not even address
disability. Most do, but oftentimes, the owners do not take the
steps to fund them.
WHAT ARE THE CHANCES OF BEING DISABLED?
The chart below shows the chances of being disabled
for 90 days or more at some point in your lifetime, based on age.
The chart shows the importance of purchasing Buy-Sell disability
agreement coverage when you are
young, since your chances of being disabled decrease over time,
as you grow closer to your retirement years. But even at age 50,
there is almost a 1 in 3 chance that you will be disabled, with
the average duration a little over 3 years. Certainly, the chart
shows the importance of planning for a disability.
HOW DOES THE COMPANY PAY AN OWNER WHO
HAS BEEN DISABLED?
For most business entities, paying an owner who
has been disabled may not be a hardship for a short period of time.
But if the payments have to continue for an extended period of time,
they can quickly create a drain on resources - especially when the
owner was an integral part of the success of the business. Payments
made to the owner will have to come from current profits and/or
a withdrawal of basis. Depending on the entity, the impact of such
a payment could be dramatic. For example, in the case of a C-Corp,
payments would most likely be a dividend. Under this situation,
the dividend would be taxable to the owner and NOT deductible to
the business. On the other hand, the profits in a Partnership or
S-Corp would still "flow through" to the disabled owner, even if
the owner were not contributing to business efforts. Should payments
exceed profits, basis will be impacted. In any case, the best time
to deal with a crisis such as the disability of an owner is before
it happens, with an Buy-Sell agreement and a disability policy
WHAT TYPE OF DISABILITY
INSURANCE IS AVAILABLE TO FUND A BUY-SELL AGREEMENT AND HOW DOES
IT WORK?
Disability Buy-Out Insurance is designed to provide
the owners with the money they need to purchase a disabled owner's
interest in the company at the agreed upon price. Once a sale price
is agreed upon, a Buy-Sell disability agreement policy is purchased to provide the funds. Two
other items need to be addressed when designing a Buy-Sell
disability agreement policy. One is
the waiting period, which is the amount of time you must be disabled
before eligibility kicks in. Typically, the standard choices are
12, 18 and 24 months. The longer the waiting period, the lower the
cost of the coverage will be. The other design issue to address
is the benefit period - over what period of time will the benefit
be paid? You can choose a lump-sum payment or payments over two,
three or five years. Some providers offer a combination of the two.
The Buy-Sell disability agreement policy can be designed to fit each individual situation.
ARE THE PREMIUM
PAYMENTS FOR DISABILITY BUY-OUT INSURANCE TAX-DEDUCTIBLE?
No. Based on current tax regulations, premiums
paid are not tax-deductible either on business or personal federal
tax returns. However, under the current federal tax laws, benefits
will be received tax-free by the company. You should consult with
your tax advisor on this issue.
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