As a business person I have become accustomed to wanting to deduct everything I can. If there was a way to deduct the air that is used in my office every day I would be installing an air gauge. Life insurance benefits are income tax free which is like the 8th wonder of the world in today’s tax to death climate. One thing that can ruin that is if you use your premium as a business expense and deduct it on taxes. You can’t have your life insurance and eat it too.
So comes the (Section 162) executive bonus plan. Simply put business life insurance can be provided by a company to supplement benefits to key employees and executives without making the death benefit income taxable. The benefits often, on top of a death benefit, are used to purchase whole life policies that build cash value and can be part of a retirement compensation plan. With an executive bonus plan, the business can use tax deductible company funds to selectively provide valued benefits to key people.
Executive bonus plans are easy to design and implement.
1. Instead of the company paying the premium, the company provides the key executive with a bonus that is taxable as income. The bonus, done correctly, is a deductible business expense for the company.
2. Since the executive is the owner of the policy the can choose whatever plan they want. A thought might be to pay into a dividend paying whole life policy for the number of years left with the company. Untouched it could become an infinite banking tool or a retirement asset. Either way the cash grows and can be removed tax free.
3. If the person dies their beneficiary will receive the death benefit income tax free since it was purchased with after tax dollars. while they will have paid tax on the premiums (the bonus), it will obviously be a hugely discounted premium.
4. Since the bonus is a form of compensation from the company to the employee or executive, it is tax deductible to the company.
The upside of Executive Bonus Plans using Section 162? Bonus plans using life insurance have several advantages:
1. An executive bonus plan is simple to set up and easy to take care of over the years. Simply give the executive or CEO a budget and let them find the life insurance plan they want. Once approved an annual bonus is paid that is equal to the premium.
2. The company can carve out who gets the benefit. In other words they can set this up selectively offered without the requirement to do likewise with any other employees in the company.
3. The bonus payments, done correctly, will be a fully deductible expense to the company.
4. The insured executive is the owner of the policy and able to name the beneficiary of the entire death benefit.
5. The executive, being the owner of the policy, will have access to cash value as it accrues or can leave it to build until retirement.
Downside of Executive Bonuses?
It is an expense that the company will not recover from the life insurance plan. This isn’t about the company, but about rewarding a CEO or executive.
Bottom line. Don’t even try to deduct life insurance premiums without complying with Section 162. The end result of taxable death benefits is costly to everyone. If you have any questions, please call or email me directly. Let’s talk.