Executive Bonus Plans IRC Section 162

Although I have studied a great deal on the tax implications the various legal business structures may incur, I am not a Tax Advisor or CPA and therefore I am not writing this to advise anything in that arena. I am merely attempting to explain as I best can interpret the tax code and how offering Life Insurance to your employees may impact your business’s tax burden.

Executive Bonus plans, also known as IRC Section 162 , are seldom discussed but frequently used avenues corporations take to incentivize and compensate high level employees. These employees are often referred to as “Key Employees”, as they are deemed crucial to the function of business operations. A successful corporation is constantly toeing the IRS line between reasonable compensation, dividend payments, and retained earnings. Under the corporate business structure, the entity must disperse “profits”, or retained earnings, towards business expenses, employee compensation, and as dividend payments to shareholders. Any unreasonable accumulation of earnings beyond these expenditures are subject to the Accumulated-Earnings Tax. Employee compensation is tax deductible to the corporation while dividend payments are not. Due to this relationship the corporation would much prefer to disperse profits by way of employee compensation so they can receive that deduction and not be further taxed, BUT WAIT the IRS thought of that…

There is also a level of employee compensation that can be deemed unreasonable by the IRS. If determined, this immediately forces a portion of the employee compensation to be treated as a dividend payment, and therefore of course now a taxable event. Section 162 allows for life insurance to be purchased on the employee by the employer, with ownership retained by the employee to be treated as a deductible way of enhancing employee compensation. This means the employer can disperse more earnings to their Key Employees without the threat of the IRS treating such payments as dividends. The employee obviously gets the death benefit payable to his heirs, but also in cash accruing policies can use that cash value per their discretion. There are policies that allow the crediting of interest of such cash value to be determined by the performance of the stock market. As long as this money is all tied to a active life insurance policy distributions to the employee can even occur without capital gains tax assessed.

In effect this is yet another of many ways in which corporations and executives can use the tax code to their benefit, work with a local financial brokerage such as Bay Life for more insight.