Business Disability (Key Person, Buy-Sell, BOE)

Business Uses of Disability Insurance

Disability income concepts extend beyond protecting an individual's paycheck. Businesses face real losses when an owner or essential employee becomes disabled: revenue may fall, fixed expenses continue, and ownership transitions can stall. Three business-purpose plans dominate the exam: Business Overhead Expense (BOE), Disability Buy-Sell, and Key Person (Key Employee) Disability. Distinguishing what each plan pays for is the most tested skill in this section.

Business Overhead Expense (BOE)

BOE insurance reimburses a small business for fixed business operating expenses while the owner is disabled, so the doors stay open and the practice can be sold or resumed. It does not replace the owner's personal salary—that is what individual DI does.

Covered (typical): rent or mortgage interest, utilities, employee salaries (non-owner), property taxes, equipment leases, accounting/legal fees, insurance premiums.

NOT covered: the disabled owner's own salary or draw, profit, cost of inventory or goods, new equipment purchases.

Key features:

• Short benefit period—usually 12 to 24 months—because it bridges the gap until the owner recovers or sells.
• Reimbursement basis: pays actual expenses incurred up to the monthly maximum, not a flat amount.
• Premiums are tax-deductible to the business as an ordinary expense; benefits received are taxable income to the business (but offset by the deductible expenses they reimburse, netting to roughly zero).

Disability Buy-Sell Insurance

A buy-sell agreement is a contract among business co-owners specifying that if one owner becomes permanently disabled, the others (or the business) will buy out the disabled owner's interest at a pre-set price. Disability buy-sell insurance funds that purchase with cash.

Distinctive features tested on the exam:

• Long elimination period—commonly 12 to 24 months—because the partners want to be certain the disability is permanent before triggering a forced buyout.
• Benefits are typically paid as a lump sum or installments equal to the buyout price, not as ongoing income.
• Premiums are NOT tax-deductible (it funds a capital purchase of an asset), and benefits are received income-tax-free.

Two Funding Structures

Key Person (Key Employee) Disability

Key person DI protects the business against the economic loss caused when a vital employee—often a top salesperson, founder, or specialist—becomes disabled. The business is the owner, payer, and beneficiary; the key employee is the insured.

• Proceeds cover lost revenue, the cost of recruiting/training a replacement, and lost goodwill.
• Premiums are NOT tax-deductible to the business; benefits are received income-tax-free.
• A meaningful elimination period applies; benefit periods are typically 1–2 years (long enough to find and onboard a replacement).

Distinguishing Key Person from Buy-Sell

Learners frequently confuse key person and buy-sell because both are owned by the business or owners and both pay tax-free benefits funded with nondeductible premiums. The distinguishing question is what the money does.

Key person proceeds replace lost operating value—revenue and the cost of hiring a substitute—while the disabled employee remains an employee. Buy-sell proceeds purchase an ownership stake, permanently transferring the disabled owner's equity to the remaining owners or the entity. If the scenario involves a non-owner employee, it is key person; if it involves an owner whose interest must be bought, it is buy-sell.

Side-by-Side Comparison (Memorize This Table)

The Tax Rule of Thumb

There is a clean pattern to memorize: when a premium is deductible, the benefit is taxable (BOE). When a premium is not deductible, the benefit is tax-free (buy-sell and key person). The IRS does not let a business both deduct the cost and receive the benefit tax-free.

Choosing the Right Plan — A Decision Walkthrough

When a question describes a business need, map it to the plan by asking what is at risk:

• If the concern is keeping the practice's lights on while the owner recovers, the answer is BOE.
• If the concern is buying out a partner who will never return, the answer is disability buy-sell.
• If the concern is lost revenue and the cost of replacing a star employee, the answer is key person.

Also distinguish ownership and beneficiary roles: in BOE and key person, the business is owner, payer, and beneficiary. In a cross-purchase buy-sell, individual owners own policies on each other; in an entity buy-sell, the business owns them. Misidentifying who owns and who collects is a frequent exam trap.