Executive Bonus Plans for Owner-Employees: How Section 162 Works for Business Owners

Short Answer: Can a Business Owner Use an Executive Bonus Plan?

Yes, a business owner who also works as an employee of the business can generally receive an executive bonus arrangement. The business pays the owner a bonus used for a life insurance premium on a policy the owner holds. The bonus is taxable compensation to the owner. The business's deduction depends on whether total pay is reasonable.

This page is for shareholders and principals of closely held companies who are weighing a section 162 plan for business owners. "Section 162 plan" and "executive bonus plan" are industry labels. They are not qualified plans, and neither the Internal Revenue Code nor the Treasury Regulations defines them. The page explains the federal income-tax mechanics when the person receiving the bonus also controls the company paying it.

Why Owner-Employee Status Changes the Analysis

When an owner approves their own bonus, the same person sits on both sides of the pay decision. Section 162(a)(1) of the Internal Revenue Code allows a deduction for "a reasonable allowance for salaries or other compensation for personal services actually rendered." Treasury Regulation 26 C.F.R. § 1.162-7(a) states the test: "whether they are reasonable and are in fact payments purely for services."

Section 1.162-7(b)(1) of the regulations says: "Any amount paid in the form of compensation, but not in fact as the purchase price of services, is not deductible. An ostensible salary paid by a corporation may be a distribution of a dividend on stock." That is why reasonableness becomes the central question.

Whether an owner who is a partner or sole proprietor, or who does not work as an employee, can receive an executive bonus is not covered here. This page covers the federal income-tax layer only. Employment-tax details and insurance rules vary, and state rules vary by state.

How Closely Held Businesses Are Typically Structured

Entity form can affect how an owner is treated, as the S corporation entry below shows.

• C corporation. A bonus paid to an owner-shareholder for services is compensation, and it is tested for reasonableness under 26 C.F.R. § 1.162-7.
• S corporation. IRS Publication 15-B (2026) treats a "2% shareholder of an S corporation" differently for some fringe benefits. For the accident or health benefit exclusion, it says the employer "can't treat a 2% shareholder of an S corporation as an employee for this exclusion."

Whether the entity form and the owner's role support a bonus arrangement needs individual review by the insurers involved and a qualified tax professional.

The Deductibility Trigger: What Puts the Premium at Risk

Section 264(a)(1) of the Internal Revenue Code provides that "No deduction shall be allowed for" premiums on any life insurance policy "if the taxpayer is directly or indirectly a beneficiary under the policy or contract." If the business is directly or indirectly a beneficiary under the policy, that rule closes off any premium deduction.

An executive bonus arrangement is structured to keep the business outside the policy. The owner-employee owns the policy and names the beneficiary. The business pays cash compensation, and the owner uses it to pay the premium. Any deduction the business claims is a compensation deduction under section 162(a)(1), not a deduction for an insurance premium.

Treasury Regulation 26 C.F.R. § 1.162-9 allows a deduction for bonuses "made in good faith and as additional compensation for the services actually rendered," provided they, "when added to the stipulated salaries, do not exceed a reasonable compensation." The ceiling comes from § 1.162-7(b)(3): "such amount as would ordinarily be paid for like services by like enterprises under like circumstances." No dollar figure sets that limit. It depends on the facts and circumstances.

How the Arrangement Works for an Owner-Employee

A typical executive bonus plan for owners moves through four steps:

1. The business pays the owner-employee a bonus, often set near the premium amount.
2. The bonus is gross income to the owner. Section 61(a)(1) of the Internal Revenue Code includes "Compensation for services, including fees, commissions, fringe benefits, and similar items."
3. The owner pays the premium to the insurer on a policy the owner owns.
4. The owner names the beneficiary and holds the policy rights. The business has no interest in the policy.

"Double bonus" is an industry term, not a term defined in the Code or the regulations. It describes a second cash bonus that offsets the owner's income tax on the premium bonus, and that second bonus is also compensation; see the site's page on double bonus arrangements. A "restricted executive bonus arrangement" (REBA) is another industry label, not a defined tax term. It adds a restriction, set by the contract's terms, on the owner's access to cash value. Its terms vary by contract. Section 83 of the Code covers property transferred in connection with the performance of services, and 26 C.F.R. § 1.83-3(c)(1) says whether a risk of forfeiture is substantial "depends upon the facts and circumstances"; see restricted executive bonus arrangements.

On the death benefit, section 101(a)(1) generally excludes from gross income amounts "paid by reason of the death of the insured." That exclusion is limited by the transfer-for-value rule in section 101(a)(2) and, for employer-owned contracts, by section 101(j). Section 101(j)(3)(A) defines an employer-owned life insurance contract as a contract owned by a person engaged in a trade or business, under which that person (or a related person) is directly or indirectly a beneficiary, and which covers the life of an insured who is an employee of the trade or business on the date the contract is issued.

Who Owns the Policy and Who Is the Beneficiary

The owner-employee owns the policy from the date it is issued. The business is neither the owner nor the beneficiary. The owner names the beneficiary, often a family member or the owner's estate. The owner also keeps the contract rights the policy provides, such as surrendering it, borrowing against it, or assigning it. Because the business is not a beneficiary, section 264(a)(1) does not reach the compensation deduction, which still has to be reasonable.

Two other structures handle ownership differently. In split-dollar life insurance, the business and the employee share interests in the policy. Which federal tax regime applies, the economic benefit regime or the loan regime, depends on who owns the policy and how the arrangement is documented. When the business owns the policy and is its beneficiary, it is employer-owned life insurance, and the notice-and-consent rules of section 101(j) come into play.

Ownership forms, beneficiary forms and procedures vary by insurer and are confirmed with the insurer. State rules vary by state.

Coverage and Funding Considerations for Owner-Employees

Permanent life insurance, such as whole life, universal life or variable universal life, may be used in these arrangements. These policies have a cash value, which is a feature of the contract, not an investment or a savings plan. The choice of policy type is made at the contract level with the insurer.

The constraint on the deduction is whether total compensation is reasonable under section 162(a)(1) and 26 C.F.R. § 1.162-7, applied to each person's pay.

Whether the business has any ongoing funding obligation, or can change or stop the bonus in later years, depends on the contracts involved. Premiums, policy charges and cash-value growth vary by contract and insurer.