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How does Disability Insurance protect a Buy-Sell Agreement?

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Disability Buy-Sell Agreements

A detailed look at two ways to guard against potential liabilities when a major shareholder becomes disabled.

Two strategies protect shareholders against the liabilities associated with another major shareholder becoming disabled.

Criss-Cross Buy-Sell Agreement

  • The agreement provides for a mandatory sale and purchase of an interest in the corporation once a shareholder has been disabled for a specified period.
  • Shareholders own disability insurance on each other to fund the purchase.
  • The agreement guarantees the purchase of the disabled partner’s business interest over the period of the policy’s payout period.
  • Premiums are paid with after-tax income.
  • Policyowners receive tax-free disability benefits.
  • Capital gains on the sale of the asset can be offset by an allowable reserve for a time if full proceeds are not collected up front.
  • Personally owned income replacement insurance is normally purchased in addition to the above coverage to provide an income (in addition to the buy-out benefit) to the disabled shareholder.

Corporate Share Redemption

  • The agreement provides for the mandatory redemption of the shares once a shareholder has been disabled for a specified period.
  • A taxable dividend, equivalent to the full amount of the purchase price, less the paid-up capital value of those shares, is deemed to have been received in the year in which the redemption of the shares takes place.
  • The dividend is subject to the Dividend Tax Credit and the Alternative Minimum Tax rules.
  • A lump-sum disability insurance contract owned by the corporation covers the funds required for the redemption.
  • The corporation could pay out an amount in addition to the redemption value to cover taxes payable by the disabled shareholder.
  • A promissory note can cover shortfalls in payment

 


 

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