Tax-Deductible Executive Bonus Plans Under Section 162

A Section 162 executive bonus plan is a selective compensation arrangement in which an employer provides a bonus to a chosen executive or key employee. The employee generally uses the bonus to pay premiums on an employee-owned permanent life insurance policy. The employer may be able to deduct the bonus as compensation when IRS requirements are met, while the employee reports the bonus as taxable income.

A business may be able to deduct a Section 162 bonus as ordinary and necessary compensation, provided the arrangement is properly structured and the amount is reasonable under applicable tax rules. The deduction is not automatic, and the executive generally recognizes the bonus as taxable compensation. A CPA should review compensation levels, entity structure, and reporting before implementation.

In a traditional Section 162 executive bonus plan, the executive owns and controls the permanent life insurance policy. The executive typically names the beneficiary and can retain the policy if employment ends, unless a separate restriction applies. This employee ownership differs from key person insurance, where the business owns the policy, pays premiums, and receives the death benefit.

A restricted executive bonus arrangement, often called a REBA, pairs an executive bonus plan with a restrictive endorsement or vesting schedule. The executive owns the policy, but certain rights—such as cash-value access, policy loans, surrender, or beneficiary changes—may be restricted until specified employment milestones are met. The arrangement can support retention while preserving the executive’s eventual ownership interest.

Section 162 executive bonus plans generally do not operate like qualified retirement plans and typically are not subject to ERISA nondiscrimination testing or qualified-plan contribution limits. That can allow an employer to select particular executives or key employees for participation. However, plan design, compensation reasonableness, taxation, and applicable employment-law issues still require review with qualified tax and legal advisers.

With a single bonus, the employer provides compensation intended to cover the policy premium, and the executive is responsible for taxes due on that bonus. With a double bonus, sometimes called a gross-up, the employer provides additional compensation intended to help offset the executive’s tax liability. The amount and reporting should be reviewed with a CPA before the arrangement is put in place.

An S corporation may use an executive bonus strategy, but shareholder-employee compensation, pass-through income, and tax reporting require careful analysis. In some situations, an S-corporation profit-loss method may be considered instead of additional W-2 compensation. The appropriate approach depends on ownership, entity facts, compensation practices, and tax circumstances, so coordinated CPA and legal review is essential.

Timing depends on the employer’s compensation decisions, executive underwriting, policy selection, and any legal or tax review. A straightforward plan can move forward after the executive applies for coverage and the insurer completes underwriting, while a restricted arrangement may need additional documentation. Begin by identifying the executive, retention goals, desired premium amount, and the professionals who should review the structure.