379 / What are the tax consequences when disability insurance is purchased on the lives of business owners to fund a disability buy-out?
Where a buy-out occurs between a corporation and a disabled shareholder, if the transaction qualifies as a complete redemption of all the shareholder’s shares, the redemption will be treated as a capital transaction ( Q 300). That is, the transaction will be considered the sale of a capital asset and the selling shareholder’s gain or loss will be measured and taxed. A disability buy-out between shareholders also is a capital transaction and is taxed accordingly.2
Where a buy-out occurs between a partnership and a disabled partner, resulting in a termination of the disabled partner’s interest, the transaction is taxed under the rules applying to a liquidation of a partner’s interest ( Q 311).
Where a buy-out occurs between partners, the transaction is taxed under the rules applying to a sale of a partner’s interest ( Q 311).