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With the onset and spread of COVID-19 in the United States, business advisors are wondering how to prepare for the virus. From a tax and insurance perspective, business overhead expense (BOE) insurance is one area to consider.
What is business overhead expense insurance?
Business overhead expense insurance pays the ongoing operating expenses of a business if the business owner becomes disabled. Another way of defining this type of insurance is to think of a BOE policy as a disability policy for a business rather than an individual. Generally, BOE insurance pays the monthly operating expenses of a business so that the business can continue to operate during the time it takes for the disabled owner to either recover from the disability or decide to leave the business. The BOE insurance benefit payments are based on the expenses of the business and not on the anticipated profits of the business.
BOE insurance is especially useful when the business relies upon a single individual to bring in business. When such an individual is not able to work, the business will be taking in very few dollars. It would likely become difficult to meet the monthly expenses of the business very quickly in such an instance without BOE insurance.
Even a business with more than one person who generates revenue for the business can benefit from having BOE insurance in place. With a business with several owners, if a single owner becomes disabled, the BOE policy will generally pay a portion of the operating expenses equal to the portion of the business owned by the disabled individual. For example, if three doctors practice together and each owns one-third of the business, the disability of one doctor would result in the BOE policy paying an amount equal to one-third of the monthly operating expenses. These payments would allow the business to continue more easily, even though the two remaining doctors would continue to generate revenue during the period of disability.
The benefit period is the length of time for which the BOE benefits will be paid. Unlike a personal disability income policy that may pay policy benefits for many years, BOE policies typically have a fairly short benefit period. Two years is a typical amount of time for a BOE policy to pay benefits.
The BOE benefit period is short because the purpose of the insurance coverage is to provide operating expenses to the business for a short period of time during which the business owner recovers from his disability. If the disability is so severe that the owner has not been able to return to work on a full-time basis within two years, then other options generally come into play. The disabled business owner may decide to sell his or her portion of the business either to existing business partners or to a third party. In other cases, the disabled owner may decide to liquidate his business assets.
Like other types of policies that pay benefits in the event of disability or illness, a BOE insurance policy usually has a waiting period. This is the amount of time that the disabled owner must wait after he has become disabled before the policy will begin paying benefits. Since the nature of the BOE coverage is generally short-term, the waiting period tends to be fairly short all, typically thirty days.
Covered operating expenses
The BOE policy’s definition of the covered operating expenses will not be the same for each policy. Generally, covered operating expenses include the following:
- Employee salaries
- Employee benefit costs
- Rent or mortgage payments for business property
- Utility costs
- Property taxes
- Accounting fees
- Legal fees
- Business insurance premiums
- Depreciation on business property
- Janitorial services
- Office supplies
- Interest on business debt
BOE insurance policies pay a maximum benefit amount, usually stated in terms of a monthly amount. However, if the actual operating expenses of the business are less than this maximum amount, the policy typically pays an amount equal to the actual expenses.
For example, assume that the BOE policy maximum monthly benefit is $2,800, and the operating expenses of the business amount to $2,300 for the month. The BOE policy will pay to the business owner only $2,300 and not the policy maximum of $2,800. With some policies, the amount of the maximum benefit that was not used for the month — $500 in our example — can be carried over to apply to future months or possibly used to extend the benefit period.
Generally, premiums paid on a BOE insurance policy are deductible as a business expense. Under a BOE insurance policy, the proceeds that are paid to the business in the event of an owner’s disability are taxable to the business. However, since most, if not all, of the business expenses paid with the policy proceeds will be deductible to the business when paid, receipt of the BOE payments may not result in increased taxation to the business.