A proper buy-sell agreement should always have provisions that assume the future needs of a small business. Although most buy-sell agreements arrange for the death of a small business owner, many buy-sell documents are quiet when it comes to the disability of a business owner. The truth is that a business owner is a lot more likely to end up disabled – than to die – when leading a business organization.
The serious effects of a small business owner’s disability are extensive: in addition to the business owner’s own health and well-being, an injury or unforeseen illness threatens the source of income of the small business owners’ families, the business itself, and the employees. The remedy to this scenario is smart, simple, and sound: Disability Buy-Out Insurance.
The Disability Buy-Out Should be Mandatory
If an accidental injury or illness hinders a small business owner from going back to work, Disability Buy-Out insurance will help fund a buy-sell agreement. It makes it possible for the remaining owners, or the entity itself, to buy-out the disabled owner’s portion of the small business.
The disability buy-out arrangement in a buy-sell agreement will guide the disabled small business owner, after a specified period of total disability (generally 12 months) to sell his/her share of the small business to the remaining owners or to the business organization itself. The remaining business owners (or the business entity) receive the funds from the disability buy-out insurance to complete the buyout.
Disability buy-out insurance is a cost-effective and well-thought out strategy for carrying out the disability buyout. It is the better business strategy in contrast to the uncertainty of other choices such as exhausting savings, taking from future earnings, or taking out small business loans.
Disability buy-out insurance premiums are certain, predictable, and anticipated. At this crucial time in the life of the small business and its proprietors, disability buy-out insurance moves the burden of financing the buyout from the individual small business owners and the business to the insurance company.
One Product with Many Solutions
In addition to providing financial security to the owners and the small business, disability buy-out insurance resolves various conflicting issues that will confront the remaining business owners and the disabled owner in the circumstance of an owner’s disability:
- Where will the business owners get the money to buy-out the disabled owner?
- Will the disabled business owner sell their interest in the business to a competitor?
- How long can the business continue to operate with the disabled business owner?
In addition to the security of protecting vital financial resources for health-related or other expenses, disability buy-out insurance funds give the disabled owner peace of mind that his or her investment in the small business will be reclaimed:
- Where is my ROI for founding and growing the business?
- Why would I let remaining business owners run the business using my money?
- How can I recover my investment capital?
Incorporating the Disability Buy-Out into the Buy-Sell Agreement
In the entity purchase buy-sell agreement, all business stakeholders enter into an arrangement with the small business, providing that the small business will purchase, and the disabled owner will sell, their stake in the small business to the business entity in the event of their total disability. The business will own and will be the loss payee of the disability buy-out insurance policy on each business owner.
Tax Implications to Consider
Irrespective of the type of buy-sell agreement, the insurance premiums paid for the disability buy-out insurance by the small business owner or by the business itself are not deductible, although the disability benefits are collected tax-free.
Although unique to the cross purchase agreement and the trusteed cross purchase agreement, if the small business bonuses the premium amount to the business owners as extra compensation, the premiums paid are deductible to the business as compensation expenses, but the insurance premiums must be incorporated in the business owner’s income.
The disabled owner may then acknowledge a capital gain on the difference between his/her basis in the small business and the amount he/she is compensated upon the sale of his/her stake.
Given that tax considerations are an essential part of solid business and personal planning, small business owners are recommended to check with their individual tax and legal experts to fully comprehend their disability coverage needs and tax status.
Consider the Options
Small business owners have the opportunity to customize the disability buy-out insurance policy to accommodate their personal and business needs. After a business owner’s total disability, the disability buy-out insurance policy may address expenses related to plans for occupational rehabilitation or the costs of adjustments or other access benefits (i.e., the installation of a wheelchair ramp) that help the business owner’s return to regular employment in his/her own occupation.
Small business owners have the freedom to choose the method in which the insurance premiums will be paid: Annually, semi-annually, quarterly, or monthly. And also to decide between three separate funding methods for accepting Disability Buy-Out Insurance proceeds (1) Lump Sum; (2) Monthly payment; or (3) Down Payment.
As a small business owner, you most likely already have a buy-sell agreement. Check with with your business advisors and evaluate the agreement to confirm that it incorporates a disability buy-out and that your agreement is effectively funded with disability buy-out insurance.