Executive Bonus Arrangements
Overview
An Executive Bonus Arrangement, under IRC Section 162, is a bonus paid to an executive in the form of a life insurance premium.
In this type of plan, the employer and employee enter into an arrangement in which the employer pays the premium on the insurance policy via a cash bonus for the employee as long as he or she remains employed by the employer. The employee recognizes the amount of the life insurance premium (cash bonus) as taxable income.
A properly structured Executive Bonus Arrangement can be an excellent tool for recruiting, retaining and rewarding key employees. It is more cost-effective for employers to retain and reward existing key employees than it is to recruit and train new employees.
It can be an excellent split dollar alternative and a way to help employees save for retirement or meet estate planning goals and provide financial protection for their families.
An Executive Bonus Arrangement is a simple way to help employees supplement other benefits, it is easy to implement, and it is not subject to ERISA.
The employee usually applies for and owns the policy, naming someone other than the employer as beneficiary. The cash bonus or premium is declared as additional compensation on the employee's W-2.
The annual taxes on this bonus are, in some cases, funded by an additional cash bonus to the employee. Eventually, the policy's annual cash value increase will exceed the tax on the bonus and may be borrowed or withdrawn to pay taxes. Policy loans or withdrawals will, of course, reduce the death benefit and may have tax consequences.
Benefits to the Employee
• Employee owns the policy, so it is portable if he or she terminates employment.
• The death benefit is income-tax-free.
• The employee's income tax liability for additional compensation can be met by borrowing or withdrawing policy cash values (with a reduction in death benefit and possible tax consequences), using policy dividends (if any), or taking an additional bonus from the employer.
• The employee can use the cash value of the policy to, among other things, supplement retirement income (with a reduction in death benefit and possible tax consequences).
Benefits to the Employer
• Salary or bonus used to pay premiums represents an ordinary and necessary business expense of the employer, and, to the extent compensation is "reasonable" in the aggregate, is tax-deductible under Section 162.
• The arrangement does not have to be prequalified by the IRS, nor is it subject to annual reporting and disclosure rules.
• There are no annual administrative costs.
• The employer may freely select the employee(s) it wishes to benefit and vary the benefit among the participating employees.
How does an Executive Bonus Plan Work?
Employer pay premium to life insurance policy as bonus to employee , the premium are tax deductible expense to employer , employee own the policy , employee report the premium as taxable income, employee can use the cash value and design the beneficiary.