'Double Bonus' Executive Bonus Arrangements: What the Industry Term Means

When a Double Bonus Arrangement May Not Fit

Some facts weaken the structure:

• Low taxable income. If the business has little taxable income, the deduction for both bonuses may matter less.
• Reasonableness limits. 26 U.S.C. § 162(a)(1) allows only "a reasonable allowance" for compensation. Total pay that includes both bonuses can exceed what is reasonable for the services rendered. Reasonableness is decided on the facts and circumstances.
• Complexity. The cascading effect means a single gross-up does not fully offset the tax, and a formula that solves for all layers adds work.
• Employer interest in the policy. If the employer wants to keep a share of the cash value or the death benefit, split-dollar life insurance is a separate structure that may be compared.
• Continuity goals. The employer receives no death benefit, so the arrangement does not on its own fund key-person or buy-sell objectives.

Tax Treatment of Both Bonuses

The federal tax treatment of both bonuses comes from the Code and the regulations, not from the "double bonus" label. "Double bonus," "section 162 plan" and "executive bonus plan" are industry terms.

For the executive. Section 61(a) of the Internal Revenue Code defines gross income as "all income from whatever source derived," including "Compensation for services, including fees, commissions, fringe benefits, and similar items." Both the premium bonus and the gross-up bonus fall within that definition. As wages, both are generally subject to income-tax withholding and employment taxes through payroll.

For the employer. 26 U.S.C. § 162(a)(1) allows a deduction for "a reasonable allowance for salaries or other compensation for personal services actually rendered." Under 26 C.F.R. § 1.162-9, bonuses are deductible "when such payments are made in good faith and as additional compensation for the services actually rendered by the employees, provided such payments, when added to the stipulated salaries, do not exceed a reasonable compensation for the services rendered." Under 26 C.F.R. § 1.162-7(b)(3), "[i]t is, in general, just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances." The same regulation measures it as of the date the services contract was made. Because the employer is not the beneficiary, the section 264(a)(1) bar is generally not what governs the bonuses. Executive bonus deductibility and reasonableness of compensation need individual review of the contracts and facts by a qualified tax professional. The employer side is developed further on the page on executive bonus tax deductibility.

The death benefit. 26 U.S.C. § 101(a)(1) generally excludes from gross income amounts paid "by reason of the death of the insured." That exclusion has limits. Under the transfer-for-value rule in § 101(a)(2), a policy transferred for valuable consideration can lose part of the exclusion. For employer-owned contracts, § 101(j) caps the exclusion at premiums and other amounts paid unless a § 101(j)(2) exception applies and written notice and consent were given before the contract was issued. Notice and consent alone do not lift the cap, and neither does an exception alone. These rules are covered on the page on business life insurance tax treatment.

Potential Advantages of the Double Bonus Approach

Several structural features explain the interest in this approach. None of them is a promised result.

• When the second bonus is sized to cover the tax on the first, the executive's out-of-pocket cost may be smaller; the tax on the second bonus itself remains unless the formula accounts for it.
• The employer may deduct both bonuses as compensation under 26 U.S.C. § 162(a)(1), subject to the reasonableness requirement.
• The executive owns the policy outright, controls the beneficiary designation and holds the cash value as a contract feature.
• The employer can offer the benefit to one or a few executives.

How the executive is taxed on these amounts is covered on the page on executive bonus plan tax treatment.

Important Considerations and Risks

Reasonableness comes first. If both bonuses push total pay above what 26 U.S.C. § 162(a)(1) treats as "a reasonable allowance," the excess may not be deductible. 26 C.F.R. § 1.162-7(b)(1) adds that where a corporation has few shareholders, practically all of whom draw salaries, and the salaries exceed those ordinarily paid for similar services and bear a close relationship to the stockholdings, the excessive payments may be "a distribution of earnings upon the stock."

Several other points follow:

• Cascading tax. The second bonus is itself gross income under § 61(a), so one gross-up layer leaves a residual tax cost.
• Employment taxes. These generally apply to both bonuses as wages.
• No employer protection. The employer receives no death benefit and no key-person or buy-sell funding.
• Departure. The policy belongs to the executive. The employer has no contractual right to recover premiums unless a separate agreement says otherwise.
• Restricted arrangements. A restricted executive bonus arrangement (REBA) is an industry term, not a Code-defined term. Industry material describes a REBA as one in which "a restrictive endorsement is placed on the policy that limits access to policy values."
• State and insurer variation. Policy forms and features vary by insurer, and insurance rules vary by state.

Tax and Legal Coordination

Coordination usually starts before the first bonus is paid. Employers can have a tax adviser look at whether total compensation, including both bonuses, falls within the § 162(a)(1) and 26 C.F.R. § 1.162-9 reasonableness standard.

Payroll is the second area. Both bonuses generally run through payroll as wages, with withholding and wage reporting.

If a REBA is used, the restriction is a term of the policy endorsement and of any related agreement the parties sign. Its terms can affect the tax result, and legal and tax professionals can review the drafting.

The death benefit's treatment under § 101(a)(1), § 101(a)(2) and § 101(j) depends on how ownership and beneficiary designations are set up. State rules on policy ownership, assignment and beneficiary designations vary by state.

Alternatives to Consider

Each alternative differs in who owns the policy, who bears the tax and what the employer keeps.

• Single executive bonus. The employer pays only the premium bonus, and the executive bears the tax. This structure is explained on the main executive bonus plan page. The label itself is examined on the page on the section 162 plan term.
• Restricted executive bonus arrangement (REBA). This variation adds a restrictive endorsement that, as industry material describes it, limits access to policy values.
• Split-dollar life insurance. The employer and executive share the policy's costs and benefits. The tax regime depends on who owns the policy and how the arrangement is structured, and this site treats it separately.

Where an existing policy would be moved into the arrangement, exchange or conversion rules may come into play. Those are separate topics.

Hypothetical Example: How the Two Bonuses Are Calculated

Hypothetical Example. Assumptions: the annual premium is $10,000, and the executive's combined federal and state marginal income-tax rate is 35%. Employment taxes are ignored for simplicity. The figures are round numbers and do not represent any reader's situation.

Step 1. First bonus = $10,000. Tax on the first bonus = $10,000 × 35% = $3,500.

Step 2. Second (gross-up) bonus = $3,500. Tax on the second bonus = $3,500 × 35% = $1,225.

Step 3. After both bonuses, the executive's residual tax cost is still $1,225. This shows the cascading effect.

Step 4. Employer's total outlay = $10,000 + $3,500 = $13,500. Both amounts are compensation and are deductible only within the § 162(a)(1) reasonableness requirement.

Step 5 (full gross-up formula). A formula covering every layer divides the premium by (1 − 0.35): $10,000 ÷ 0.65 ≈ $15,385, the combined amount of both bonuses. Tax on that amount is $15,385 × 35% ≈ $5,385. That leaves about $10,000 for the premium.

Actual tax rates, premiums and outcomes vary. This illustration is not a coverage or tax recommendation.