The main purpose of disability insurance is to to replace an individual's income should they be unable to work as a result of either an accident or a sickness. In this article, we will discuss the disability insurance tax and non-tax perspective for buy-sell policies tax.
1. Non-tax perspective
if the corporation owns the policy and benefits are payable to the corporation, the benefits may be able to be claimed by corporate creditors. As well, when there are a number of shareholders involved in the buy/sell agreement and insurance, the allocation of premium costs need to be addressed.
2. Tax perspective
The premiums payable on these types of plans cannot be deducted from taxable income of the corporation. Therefore, on an after-tax basis, it may be less expensive to have the policies owned by the corporation provided it is taxed at the small business rate. In some cases, the buy/sell agreement will require the individual business owners to buy the interest of a disabled owner. the disability buy-out policies must be structured on a “criss-cross" basis. In other words, each business owner will own and pay the premiums on one or more policies which insure the other business owners.
1. When the disability policy is owned individually and the insured business owner becomes disabled and remains disabled for the length of the Elimination Period, the healthy owner will receive benefits under the disability policy on a tax-free basis. The healthy owner will use these disability benefits to purchase the shares of the disabled owner. As a result, the disabled owner will be responsible for any capital gains that arise from the sale of their business interest. If the business qualifies as a small business corporation, the disabled shareholder may have access to the enhanced capital gains exemption. The healthy owner will increase the adjusted cost base of their interest in the business by the amount they paid for the disabled owner's shares.
2. In situations where the buy/sell agreement requires the corporation to buy out a disabled partner, the tax consequences are significantly different from a criss-cross purchase arrangement. The corporation purchases the disability policies to fund the disability buy-out. The corporation receives the disability benefits on a tax-free basis, but there is no mechanism such as the capital dividend account that allows the benefit to be paid to either the healthy or disabled shareholders on a tax-free basis.
3. If the corporation uses the insurance proceeds to redeem the disabled shareholder's shares, the tax department will rule that there is a deemed dividend for the disabled shareholder. The dividend is the amount that the proceeds of the redemption of the shares exceed the paid-up capital cost of the shares. The healthy shareholders, however, do not receive an increase in the adjusted cost base of their shares, even though their shares have increased in value due to the redemption of the disabled shareholder's shares.
4. Another approach is that the insurance proceeds can be distributed to the healthy shareholders as a taxable dividend or bonus. The healthy shareholders then use these funds to buy the shares of the disabled shareholder. The disabled shareholder is then responsible for any capital gains tax arising from the purchase of the shares by the healthy shareholders.
I hope this information will help.
If you need more information of the above subject, please visit my home page at: Kyle J. Norton http://lifeanddisabitityinsuranceunderwriter.blogspot.com/
All rights reserved. Any reproducing of this article must have all the links intact. I have been studying natural remedies for disease prevention for over 20 years and working as a financial consultant since 1990