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

Disability Coverage for Businesses

Individual DI protects a worker's paycheck, but businesses also suffer financial loss when an owner or essential employee becomes disabled. The exam tests three distinct business DI products, and the key is matching the right product to the right loss.

The three products are Key Person disability, Disability Buy-Sell, and Business Overhead Expense (BOE). Each insures a different exposure, pays in a different way, and is taxed differently.

Key Person Disability

A key person (key employee) is someone whose disability would cause a measurable loss to the business—lost sales, lost expertise, or the cost of finding a replacement.

• The business is the applicant, owner, premium payer, and beneficiary.
• The employee is the insured.
• Benefits help the company absorb lost revenue and hire/train a replacement.
• Premiums are not deductible; benefits are received income-tax-free by the business.

Key person coverage usually has a longer elimination period (often 30–90 days) because short absences do not threaten the firm.

Disability Buy-Sell

A disability buy-sell policy funds the purchase of a disabled owner's share of the business by the co-owners or the entity. It works like a life-insurance buy-sell but triggers on disability instead of death.

• Funds the buyout of a permanently disabled owner's interest.
• Typically uses a long elimination period (often 12 to 24 months) so the buyout occurs only after disability is clearly permanent.
• Usually pays a lump sum or structured installments rather than monthly income.
• Premiums are not deductible; benefits are received tax-free.

This product preserves business continuity and gives the disabled owner a defined exit value.

Business Overhead Expense (BOE)

BOE reimburses the fixed operating expenses of a small business or professional practice while the owner is disabled, so the doors stay open until the owner returns or sells.

Covered expenses include rent, utilities, employee salaries (non-owner), leases, property taxes, and accounting fees. Not covered: the owner's own salary or draw, and the cost of inventory or goods.

• Reimburses actual monthly expenses up to a stated maximum.
• Short elimination period (often 30 days) and short benefit period (commonly 12–24 months).
• Premiums ARE tax-deductible as a business expense; benefits are taxable but offset by deductible expenses they reimburse.

Key Person and Buy-Sell Mechanics

Three business-DI products solve different problems:

• Key person DI — the business owns the policy, pays the premium, and receives the benefit to offset lost revenue and the cost of finding a replacement when a vital employee is disabled. Premiums are not deductible; benefits are tax-free to the business.
• Disability buy-sell — funds the buyout of a disabled owner's share under a buy-sell agreement, usually after a long elimination period (e.g., 12 months) and often paid as a lump sum or installments. It guarantees the disabled owner gets paid and the remaining owners gain full control.
• Business overhead expense (BOE) — covered separately below.

A common exam distinction: key person replaces lost earnings/value to the company, while buy-sell transfers ownership — different purposes, different payees.

Business Overhead Expense (BOE) and Taxation

BOE insurance reimburses the fixed operating expenses of a small business — rent, utilities, employee salaries, equipment leases, property taxes — while the owner is disabled, keeping the doors open until recovery or sale. It does not replace the owner's personal income (that is individual DI) and it covers only actual expenses up to a monthly cap, making it a reimbursement contract.

BOE premiums are a tax-deductible business expense, but the benefits are taxable to the business as income (offset by the deductible expenses they reimburse, so the net effect is roughly neutral). The exam contrasts BOE's deductible-premium/taxable-benefit treatment with key person DI's non-deductible-premium/tax-free-benefit treatment — the mirror rule applies to businesses just as it does to individuals.

Choosing the Right Business Product

A fact pattern that emphasizes continuing fixed expenses while a sole proprietor recovers points to BOE; one that emphasizes purchasing a disabled partner's share points to buy-sell; one about lost revenue from a star salesperson points to key person. Buy-sell policies usually carry a long elimination period (often 12-24 months) because permanent buyout should not be triggered by a short-term disability. Matching the business problem to the correct contract — and its tax treatment — is the core exam task here.

Worked Buy-Sell Funding Example

Two equal partners own a business worth $1,000,000; each share is worth $500,000. They fund a disability buy-sell with a 12-month elimination period. Partner A becomes permanently disabled. After the 12-month waiting period confirms the disability is lasting, the policy pays $500,000 (lump-sum option) to buy out A's interest, transferring full ownership to Partner B.

A receives fair value without having to find an outside buyer, and B gains uncontested control. The long elimination period exists so a temporary disability does not prematurely force a permanent ownership change — a detail the exam reliably tests against shorter individual-DI elimination periods.