What happens when a Business Partner becomes disabled?

1. Disability Buy/Sell Contracts What happens when a Business Partner becomes disabled? • Would they want to sell their share of the business? • Would they want to buy out the healthy partner(s)? • How would the price be determined? • Where would the money come from? • Is it guaranteed to be there when it’s needed?

2. In the Event of a Disability,There Are Many Issues to be Resolved The disabled partner may: • Become a drain on income while not contributing to the business • Have different priorities for the business income and profits and may not want to reinvest profits • Decide to let their spouse or relative take over his/her role in the business

3. In the Event of a Disability, there are Many Issues to be Resolved The healthy partner: • May not be able to pay the disabled partner an income and maintain the business • May not have funds to buy the disabled partner out • May not want to share business decisions with the disabled partner’s family

4. Advantages of a Buy-Sell Agreement • Assures active business owner can buy out the disabled owner at a predetermined price and pre-arranged time after disability strikes. • Maintains business continuity and credibility - which are concerns of customers, creditors and employees.

5. Advantages to the Disabled Business Owner • Creates an automatic market by guaranteeing a definite and fair price and a buyer for the business interest • Assures that his/her financial future is no longer contingent upon the strength of the business • Provides money which may be needed to pay medical bills and living costs • Avoids involving the disabled owner and his/her family in the management of the business

6. Advantages to the Active Business Owners • Avoids negotiation of price • Assures complete and orderly transfer of ownership • Retains control of the business • Competitors cannot purchase the disabled owner’s business interest in the firm and force out the active owners

7. Once Again, Consider The Likelihood... Commissioner’s Individual Disability Table B - Equally Weighted 90 Day Elimination Period.

8. Buy-Sell Considerations • Date to Establish a Plan • The date the owner first becomes disabled; or • The trigger date of the buy-sell agreement • Method of payment • When is the first payment due? • How should it be paid? • Lump sum payment • Monthly installments • Combination of both

9. Buy-Sell Agreement Considerations Structure of the agreement: • Cross-purchase agreement • Works best with two owners • Insurance company reimburses the non-disabled owner(s) • Receive step up in basis • Entity purchase agreement • Insurance company reimburses the corporate entity • Best to use with multiple owners

10. The most practical solution is... • A written agreement that specifies when and for how much the buy-out will take place, and... • is funded with the right amount of Disability Buy-Sell insurance.

11. Why Disability Buy-Out Insurance? • Objective • The objective of Disability Buy-Sell insurance is to reimburse money paid for the purchase of a disabled owner’s interest in the business in the event of a long-term disability • Benefits • Benefits are income tax-free - the disabled owner is taxed only on the gain from the sale of the business* • Provides a funding solution for the business

12. How Does it Work? • The non-disabled owner(s) are reimbursed for buy-out expenses paid during the buy-sell process • Premiums are non-deductible (IRC 265; Rev. Rul. 66-262, 1966-2 C.B. 105) • Benefits are received income tax-free (IRC 104(a)(3); Rev. Rul. 66-262, 1966-2 C.B. 105) • The disabled owner is taxed only on the gain from the sale of the business. The gain may be considered an installment sale if at least one payment is to be received after the close of the tax year in which the sale was made. Clients should contact their tax advisor for details.

13. Cross Purchase Agreement • Each owner owns a policy on each of the other owners • After disability, the non-disabled owner(s) purchase the disabled owner’s share in accordance to the Buy-Sell Agreement and receives policy benefits (up to the maximum policy limit) as a reimbursement • The non-disabled owner(s) then own the business, and the disabled owner has been paid the price agreed upon

14. How a Cross Purchase Agreement Works Business Owner A Business Owner B Buy-Sell Agreement Premium Premium Insurance Company Policy and Disability Benefits on Owner B Policy and Disability Benefits on Owner A

15. Advantages Policies are not available to business creditors Non-disabled owners receive an increase in their basis Disadvantages If there are more than two owners, the number of policies needed may not be practical Advantages/Disadvantages of a Cross Purchase Agreement

16. Entity Purchase Agreement • The business purchases and owns a disability buy-out policy on each owner • After disability, the business purchases the interest of the disabled owner in accordance to the buy-sell agreement and receives policy benefits (up to the maximum policy limit) as a reimbursement • The non-disabled owners then own the business, and the disabled owner has been paid the price agreed upon

17. How an Entity Purchase Agreement Works Business Owner A Business Owner B Buy-Sell Agreement Buy-Sell Agreement Business Policy and Disability Benefits on Owners A and B Premium Insurance Company

18. Advantages Only one policy per business owner is necessary Disadvantages Policies are open to claims by creditors The buy-out will not increase the healthy owner’s basis Advantages/Disadvantages of an Entity Purchase Agreement

19. Ideal Candidates • White to Gray Collar, small to medium-sized businesses with less than 10 owners • 10% ownership to be considered • Need to have a plan for succession • Owners that depend on each other to keep the business running smoothly

20. Common Methods to Calculate Business Value • For Personal Service Businesses: - 2 times income plus the profit of the business • For General Businesses: - Book value plus capitalization of excess earnings

21. Elimination Periodsand Pay Out Methods • 365, 540, or 730 Day Elimination • Lump Sum • Monthly Installments over 2, 3, or 5 Years • Combination of Lump Sum and Monthly Installments

22. Issue and Participation Limits • Total Pay Out: Up to $2,000,000 • Limits per Occ Class • Limits per Pay Out Method • Limits per Elimination Period

23. Disability Buy/Sell Underwriting • Financial: Most Recent Business Tax Returns, all schedules. (Three Full Years Preferred) • Medical: Telephone Interview (all amounts and ages), Blood/Urine, Para Med, EKG (by amount, age, and state)

24. Disability Buy/Sell Carriers • Berkshire/Guardian • MassMutual • MetLife • Principal • Standard