10.3 Business Disability (Key Person, Buy-Sell, BOE)
Key Takeaways
- Key person DI is owned by and paid to the business to offset the financial loss of a key employee's disability; premiums are not deductible and benefits are tax-free.
- Disability buy-sell funds the purchase of a disabled owner's interest and uses a long (12-24 month) elimination period to confirm permanence.
- BOE reimburses ongoing fixed business expenses (rent, utilities, non-owner salaries) but NOT the owner's salary; it has a short elimination and benefit period.
- BOE is the tax exception: premiums are deductible and benefits are taxable, usually netting to a wash.
- Distinguish the three by policyowner, purpose, and tax treatment - a common exam confusion point.
Disability does not only threaten an individual's paycheck; it can cripple a business that depends on a key owner or employee. The exam tests three distinct business DI products. Each solves a different problem, has a different policyowner/beneficiary, and is taxed differently — confusing them is a classic trap.
Key Person (Key Employee) Disability Insurance
A business buys this on the life/health of an employee whose disability would cause financial loss — typically a top salesperson, founder, or specialist whose absence reduces revenue or raises costs (recruiting, lost contracts).
| Element | Treatment |
|---|---|
| Applicant / policyowner | The business |
| Premium payer | The business |
| Premium deductible? | No — not a deductible business expense |
| Benefit recipient | The business |
| Benefit taxable? | No — received income-tax-free by the business |
| Insurable interest | Required at application; lost-revenue justification |
The business uses the benefit to cover the financial hit of the key person's absence — hiring temporary help, recruiting a replacement, or offsetting lost sales.
Disability Buy-Sell Insurance
When co-owners agree that a disabled partner's interest will be bought out, a disability buy-sell agreement is funded with DI. The benefit provides the cash to purchase the disabled owner's share, so the remaining owners gain full control and the disabled owner (or family) receives fair value.
| Element | Treatment |
|---|---|
| Purpose | Fund the buyout of a disabled owner's business interest |
| Elimination period | Long (often 12-24 months) — to confirm the disability is permanent before forcing a sale |
| Premium deductible? | No |
| Benefit taxable? | No — proceeds used to purchase the interest are received tax-free |
| Payout form | Often a lump sum or installments equal to the purchase price |
The long elimination period is a frequently tested distinction: a buyout is irreversible, so the policy waits a year or more to be sure the owner will not recover.
Business Overhead Expense (BOE) Insurance
BOE reimburses a disabled owner for the ongoing fixed expenses of running the business so it can stay open during recovery.
- Covered expenses: rent or mortgage interest, utilities, employee salaries (non-owner), property taxes, insurance premiums, leased equipment, depreciation.
- NOT covered: the disabled owner's own salary or draw (that is what personal DI is for) and the cost of hiring a substitute to do the owner's job.
- Benefit type: reimbursement — pays actual expenses incurred up to the monthly maximum, so it does not overpay.
- Elimination period: short (often 30-90 days); benefit period: short (often 12-24 months).
A small architecture firm wants coverage that keeps paying the office rent, the receptionist's salary, and utility bills if the owner becomes disabled, so the practice stays open. Which policy fits?
Taxation of Business DI — A Comparison
| Product | Premiums deductible? | Benefits taxable? | Why |
|---|---|---|---|
| Key person DI | No | No | Business is both payer and recipient |
| Disability buy-sell | No | No | Funds a capital purchase of an interest |
| BOE | Yes | Yes | Premiums are a deductible business expense; reimbursements are taxable income, but offset by the deductible expenses they reimburse |
BOE is the exception worth memorizing: its premiums are tax-deductible to the business and its benefits are taxable — but because the benefits reimburse deductible expenses, the net tax effect is usually a wash.
Exam trap: Do not assume the owner's salary is a covered BOE expense — it is not. The owner protects personal income with an individual DI policy, while BOE protects the business's fixed overhead.
Funding Methods and Underwriting Considerations
Disability buy-sell agreements can be funded three ways, and the exam expects you to recognize each:
- Cross-purchase — each owner buys a policy on every other owner; benefits flow directly to the surviving owners who then buy the disabled owner's share.
- Entity (stock-redemption) — the business owns one policy per owner and redeems the disabled owner's interest.
- Cross-purchase trust / wait-and-see — a hybrid that defers the choice until disability occurs.
Underwriting business DI requires documenting the financial loss the coverage replaces. Key person coverage must justify the benefit by the key employee's contribution to revenue or profit. BOE underwriting verifies actual monthly overhead through financial statements, because BOE is a reimbursement product that cannot pay more than expenses incurred. Buy-sell underwriting values the business interest to set the purchase price the policy will fund.
Worked example — BOE reimbursement cap
A practice carries a $10,000/month BOE benefit. In a covered month its eligible fixed expenses (rent, staff salaries, utilities) total only $7,500. BOE reimburses the $7,500 actually incurred — not the full $10,000 — because it is a reimbursement, not a fixed-indemnity, contract. Many BOE policies let unused monthly amounts carry forward to later high-expense months until the total benefit pool is exhausted.
A practical exam distinction: BOE has a short benefit period (commonly 12–24 months) because its purpose is to keep the doors open long enough for the owner to recover or arrange an orderly sale, not to fund the business indefinitely. Disability buy-sell, by contrast, deliberately uses a long elimination period for the opposite reason — the buyout must wait until the disability is confirmed permanent. Lining up these timing features by purpose is the fastest way to keep the three business products straight on test day.