272 / What is a Section 162 bonus plan and what are the income tax consequences to an employee and employer?

An IRC Section 162 bonus plan or an executive bonus plan is a nonqualified employee benefit arrangement in which an employer pays a compensation bonus to a selected employee who then uses the bonus payment to pay premiums on a life insurance policy insuring his or her life. (Often, as a convenience, the employer will pay the bonus directly to the insurer on behalf of the employee. See Q 269.) The policy is owned personally by the employee.

A compensation bonus generally is deductible to a corporate employer if an employee’s total compensation is a reasonable amount.¹ Whether used to pay policy premiums or not ( Q 269), a compensation bonus is includable in gross income to an employee.² At death, policy death proceeds are received by an employee’s beneficiary income tax-free ( Q 63).³ Any policy withdrawals, surrenders, or loans made by an employee are taxed as they would be if the employee had purchased the policy without the benefit of the bonus arrangement ( Q 10, Q 13, Q 30).