When creating a business plan, the owner of the company must account for all of the risks associated with the operation. On of the greatest risks is disability. It is said that 50% of persons aged 35 and over will experience some sort of disability before they reach the age of 55. The question a business owner must ask is; can my business survive if I was to become disabled for a period of time? The answer: in most cases the business can not continue on. Business owners must protect their business by purchasing business overhead expense insurance.

Definition
This insurance policy is designed to cover the operating expenses of a business if the owner of the business has become totally or partially (depending on the structure of the policy) disabled. This coverage differs than individual disability in that individual disability covers personal expenses in the event the owner becomes disables. As mentioned, this policy covers the business expenses. The expenses the policy is designed to cover typically include...

  • Payroll (employee)
  • Rent
  • Utilities
  • Taxes
  • Accounting and legal fees
  • Insurance expense
  • Office supplies

Structure
Unlike individual disability most business overhead expense policies have duration of 1 or 2 years. Generally, these policies also carry shorter elimination periods than individual disability. The elimination periods are typically 30 or 90 days. The policy's can also be designed to be noncancelable or guaranteed renewable.
  • Noncancelable - policy is guaranteed renewable until the contract anniversary date and the premiums do not change.
  • Guaranteed Renewable - policy is guaranteed renewable until the contract anniversary date and the premiums may change.

In most cases the policy will reimburse fixed operation expenses. Typically, the insurance company will require the owner to produce supporting financial statements when applying for the policy.

Tax Considerations
As with any other business expense the owner of the business needs to consider the tax consequences of purchasing a policy. The premiums paid by the business to purchase the policy are tax deductible. However, benefits from the policy to cover monthly operating cost are taxable.

Practice Question:
Dr. Jane Jones owns and operates a medical practice. She is the sole owner of the practice and has 3 employees working for her. Dr. Jones sees about 25 patients a week and carries an ongoing operating expense of $30,000 a month. All of the expenses are covered with the cash flow Dr. Jones generates from seeing her patients. She is concerned that if she were to become disabled her business would suffer and she would have to downsize her practice. You have recommended that she purchase business overhead expense insurance. After your recommendation Dr. Jones asks you, if I were to purchase this insurance how much of the premium can I deduct and if I receive benefits from the policy do I have to include that as taxable income for the business?

25% of the premium is deductible; 0% is included as taxable income
75% of the premium is deductible; 100% is included as taxable income
100% of the premium is deductible; 50% is included as taxable income
100% of the premium is deductible; 100% is included as taxable income
0% of the premium is deductible; 0% is included as taxable income

Answer: D
The IRS allows a business to deduct 100% of the premium paid, but if benefits are received from the policy the IRS includes 100% of the benefit as taxable income for the business.


An Introduction to the Insurance Needs Approach

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