December 1, 2016
Let’s take a look at two preventative financial manoeuvres to guard against potential liabilities if a shareholder became disabled.
Criss-Cross Buy-Sell Agreement.
- The agreement provides for a forced sale and purchase of an interest in a corporation when a shareholder becomes disabled for a specified period.
- Shareholders own disability insurance on each other to fund the purchase.
- The agreement guarantees the purchase of the disabled partner’s business interest over the policy’s payout period.
- Premiums can be paid with after-tax income.
- Policyowners receive tax-free disability benefits.
- Capital gains on the sale of the asset are offset by an allowable reserve for a time if full proceeds are not collected up front.
- Personally owned income replacement insurance is commonly purchased to provide an income (in addition to the buy-out benefit) to the disabled shareholder.
Corporate Share Redemption
- The agreement provides for the mandatory redemption of the disabled owner’s shares.
- A taxable dividend, equivalent to the full amount of the purchase price, less the paid-up capital value of those shares, is deemed to have been received in the year in which the redemption of the shares takes place.
- The dividend is subject to the Dividend Tax Credit and the Alternative Minimum Tax rules.
- A lump-sum disability insurance contract owned by the corporation covers the funds required for the redemption.
- The company could pay out an amount in addition to the redemption value to cover taxes payable by the disabled shareholder.
- A promissory note can cover shortfalls in payment.
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