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Hong KongBusiness overhead expense and disability buyout
Business overhead expense pays the fixed costs of running a business while the owner is disabled, and never the owner's own income. Disability buyout funds the purchase of a disabled owner's interest. A key employee policy pays the business for the cost of losing a valuable employee to disability.
Three of the five sub-items under disability income are business policies, and they are separated in exactly the way the life-side business products are: by asking what the money is for.
The three, and what each one buys
| Policy | Pays for | Who receives it | Trigger |
|---|---|---|---|
| Business overhead expense | Rent, utilities, staff wages, leases | The business | The owner's disability |
| Disability buyout | The purchase price of a disabled owner's share | The buying owners or the business | Disability that is likely permanent |
| Key employee disability | The cost of losing and replacing a key employee | The business | The employee's disability |
None of the three replaces anybody's salary. That is the fact every distractor in this heading is built on, and it is why an owner with overhead expense cover still needs an individual disability income policy of her own.
Business overhead expense in detail
- It reimburses actual expenses incurred, up to the policy limit, rather than paying a fixed sum.
- Covered items are the fixed costs of keeping the doors open: rent, utilities, leased equipment, employee wages, professional fees.
- The owner's own salary and any profit distribution are excluded.
- Benefit periods are short, because the point is to keep a practice alive long enough to recover or to sell it.
- Premiums are deductible to the business and benefits are taxable to it, since it is deducting the expenses they cover.
The tax line at the end runs opposite to the personal disability rule, and it is deliberate. The business deducts the premium and takes the benefit into income, then deducts the expenses the benefit pays. It nets out, which is the whole design.
Disability buyout
A buy-sell agreement usually covers death and disability, and life insurance funds only the first. Disability buyout funds the second. The awkwardness is that death is a fact and disability is a judgment, so these policies define the triggering condition carefully and typically require the disability to have lasted a substantial period before the purchase is funded.
Benefits are commonly paid as a lump sum or in installments rather than as monthly income, because the money is buying an asset rather than replacing a wage.
A practice owner might reasonably hold an individual disability income policy for her salary, a business overhead expense policy for the practice's costs, and a disability buyout policy under her partnership agreement. Each pays a different party for a different loss out of the same event, and a stem listing two of the three is usually asking which one is missing.
A dentist with a business overhead expense policy becomes disabled. During her disability the practice continues to pay rent, the hygienist's wages and her own salary. What does the policy cover?
- All three, since they are the practice's costs
- Rent and wages, but not her salary
- Her salary only, since she is the insured
- Rent only, since wages are variable
Where it sits
- Section
- V, types of accident and health policies, 16 questions
- Listed as
- Disability income, sub-items 2, 3 and 5
- Life-side equivalent
- Key person and buy-sell insurance, section IV
- Our estimate
- One question, ours and not published
Study these alongside the life-side business products rather than weeks apart. Key person life and key employee disability are the same idea answering two different events, and so are buy-sell life funding and disability buyout. Learning them as pairs halves the work.
The opinion, and the concession
One question, probably. It is worth fifteen minutes because the distinction is crisp and the distractors are predictable: every wrong answer in this heading involves paying somebody's salary. Once you have noticed that, the questions answer themselves.
The concession: the tax treatment above is federal and we hold no federal tax source, so treat it as the standard position rather than as advice. Benefit periods and definitions of the qualifying disability are contract terms and we print no figures for them. The exam asks what each product pays for, which is the part that does not vary.
Common questions
Does business overhead expense insurance replace the owner's income?
No, and that is the defining feature. It reimburses the fixed costs of running the business while the owner is disabled: rent, utilities, leases, staff wages and professional fees. The owner's own salary needs a separate individual disability income policy.
What does a disability buyout policy do?
It funds the purchase of a disabled owner's interest under a buy-sell agreement, in the same way life insurance funds the purchase on a death. Benefits are typically paid as a lump sum or in installments, because the money is buying an asset rather than replacing income.
How are business overhead expense benefits taxed?
The premium is deductible to the business and the benefits are taxable to it. Because the business then deducts the expenses the benefit is paying, the effect broadly nets out. That is the reverse of an individually paid personal disability policy, where premiums are not deductible and benefits are tax free.
Why is disability harder to define than death in a buy-sell agreement?
Death is a fact and disability is a judgment that can change. Buyout policies therefore define the triggering condition tightly and usually require the disability to have continued for a substantial period before funding the purchase, so the business is not forced to buy out an owner who recovers.