Under a section 162 Executive Bonus Plan, the employee takes each year’s bonus into taxable income as received or when the premium is paid by the company. Some companies will gross up or pay an additional bonus to pay for projected income taxes and payroll taxes attributable to the bonus. Since the employee owns the life insurance policy or non qualified deferred annuity, they will have access to policy values.
In that the employee takes each bonus into income, the employer may deduct each bonus. The only exception to the bonus being deductible is if the IRS would rule that the employee’s total compensation is unreasonable. If that is the case, the employer would be limited in how much they can deduct but the employee would still take all of the compensation into taxable income. See IRC Regulations.1.162-7(b) (3).
What are the ADVANTAGES to each party?
Employer selects which executives they wish to benefit
Employer chooses benefit level and can customize for each executive
162 Executive Bonus Plan easy to implement and administer
No administration other than regular payroll
Bonuses may be fully deductible to employer under IRC 162
Rewards and retains Key Employees
Plan can be terminated by company at any time
Employee owns the policy and policy values
Employee gets to name beneficiaries
Accumulating values can be accessed by employee
Tax deferred growth on accumulations
Tax free death benefit in case of Life Insurance
Life insurance can benefit survivors and pay estate costs
Cash values available for emergencies
Cash values may be used to supplement retirement income
What are the DISADVANTAGES to each party?
The company has very little control of the life insurance policy or annuity
Executive:The Key Executive must include the bonus paid in their taxable income
If an annuity is used, an IRS penalty of 10% may apply on withdrawals from annuities prior to age 591⁄2
Withdrawals from a life insurance
5 Pros to Using Cash Value Life Insurance in an Executive Bonus Plan
Customizable Employee Bonus Plan: the employer can add certain incentives to the plan in order to retain the employee and/or require the employee to reach certain performance benchmarks.
Employer Selects Key Employees: Executive bonus plans are non-qualified plans, which allows the employer to choose which employee(s) to offer the plan to, instead of providing the benefit to the entire work force.
Employer’s Income Tax Deduction: The employer receives a tax deduction for the premiums paid into the employee’s policy.
Simple to Set Up and Implement: The major step is to have the Key Employee qualify for life insurance coverage.
Employee Uses Accrued Cash Value to Supplement Retirement Income: the employee would not be taxed on the cash value up to the basis since the premiums have already been taxed.
Cons to Using Life Insurance in an Executive Bonus Plan
Portability: Depending on your vantage point, the portability of the policy may be a pro or con of using life insurance in an executive business plan. When the employee leaves, the life insurance policy goes with the employee. The employer can cease making payments but the valuable employee, and his or her policy, has left the company. Of course, the portability of the policy is a positive for the employee.
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