Disability Stock Redemption Buy-Sell Agreement

Example: Crown Manufacturing Inc. has been recently valued at $300,000, and is owned equally by three principals. The corporation buys, owns and pays for disability buy-sell policies in the amounts of $90,000, on each of the three shareholders, electing the lump-sum method.

If Owner A is disabled, a lump-sum benefit will be paid to the corporation or designated trustee when the elimination period is completed. The corporation then buys Owner A's interest with the policy proceeds of $90,000 and makes up the $10,000 balance from earnings. Consequently, Crown Manufacturing will still have a fair market value of $300,000, but will now have just two principals.

Tax treatment

When disability buy-sell insurance is used to fund buyout agreements:

• The premiums are not tax deductible.
• At disability, the buyer receives benefits tax-free and, following the elimination period spelled out in the contract, uses them to buy the business interest under the terms of the agreement.
• The sale of the business interest is a capital gains transaction to the seller.

Advantages to the active owners

• Guarantees the disabled owner's interest can be purchased at a specific price.
• Guarantees the active owners will maintain control of the business.
• Helps maintain a smooth flow of business activity and builds goodwill and confidence among customers, creditors and employees.

Since the buy-sell policy will provide funds for the purchase, there will be no disruption of cash flow or drain on surplus, and there is no need to borrow or use the business's future income.

Advantages to the Disabled Owner

• Guarantees a ready market for the disabled owner's business interest, at an agreed-upon price.
• Money from the purchase can be used to pay the disabled owner's unexpected medical bills and other expenses, thus protecting the rest of the family estate.
• Makes it unnecessary for the spouse or children of the disabled owner to become active in the business in order to protect their interests.
• Protects the disabled owner from any future losses incurred in the business.

In addition, active and disabled owners benefit from having agreed in advance on the trigger point that implements a buyout.

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