Executive Bonus / Section 162
How an Executive Bonus Plan Works, Step by Step
Published October 9, 2026 · Updated October 9, 2026
Short Answer: What Happens in an Executive Bonus Plan
In an executive bonus plan, an employer pays a selected executive a bonus, and the executive uses it to pay premiums on a permanent life insurance policy the executive owns. The bonus is taxable compensation to the executive. The employer may deduct it as compensation, but only to the extent total pay is reasonable for services actually rendered.
Business owners, officers and finance leads usually ask this when weighing a selective benefit for a few key people. "Executive bonus plan," "section 162 plan," "restricted executive bonus arrangement" (REBA) and "double bonus" are industry terms. None is a qualified plan, and none is defined in the Internal Revenue Code or Treasury regulations. The arrangement rests on general compensation rules: 26 U.S.C. § 162(a)(1) for the employer's deduction, and 26 U.S.C. § 61(a) with 26 C.F.R. § 1.61-2(d)(2)(ii)(A) for the executive's income. A separate rule, 26 U.S.C. § 264(a)(1), allows no deduction for premiums on a life insurance policy if the taxpayer "is directly or indirectly a beneficiary under the policy or contract." In the standard arrangement the executive, not the business, owns the contract and names the beneficiary. For the concept itself, Business Life Insurance has an overview of executive bonus plans.
The Planning Objective: Why Businesses Use This Structure
The underlying business problem is people, not insurance. A closely held company or professional practice often depends on a handful of executives whose departure would disrupt operations, client relationships or a future ownership transition. The company wants to attract, reward and keep those people without extending the same benefit to every employee.
Broad-based qualified retirement plans generally have to cover a nondiscriminatory group, so they are a blunt tool for this goal. A bonus is different: the employer decides who receives it. Life insurance enters only as the funding mechanism. The bonus pays for an individually owned permanent policy, which gives the executive death-benefit protection for a family and a contract with a cash value feature. The policy is the executive's property, so it can go with the executive when employment ends, subject to any agreed restriction. The plan is the compensation arrangement; the policy is what the compensation buys.
How the Structure Works: The Flow of Money and Ownership
The steps below describe the arrangement in its basic form.
- Agreement. The employer and executive agree on a bonus amount that equals or covers the policy premium.
- Payment. The employer pays the bonus to the executive, or in some arrangements pays the premium directly to the insurer on the executive's behalf. A bonus is compensation for services under 26 U.S.C. § 61(a)(1). For a premium the employer pays directly, 26 C.F.R. § 1.61-2(d)(2)(ii)(A) provides that, generally, "life insurance premiums paid by an employer on the life of his employee where the proceeds of such insurance are payable to the beneficiary of such employee are part of the gross income of the employee."
- Ownership. The executive applies for and owns the policy, completes underwriting, and names a personal beneficiary. Insurer materials note that the executive may instead name a third party, such as a trust, as owner.
- Premium. The executive pays the premium from the bonus received.
Double bonus. This industry term, not a Code term, describes a variant in which the employer increases the bonus to cover the executive's income tax on the bonus itself. The extra amount is also compensation.
REBA. In a restricted executive bonus arrangement, the terms agreed between employer and executive, and an endorsement placed on the policy when it is issued, limit the executive's access to the policy values, while the executive keeps the right to name and change the beneficiary. It is used as a retention device. The restriction is contractual, not a Code-defined status.
Because the executive owns the policy and names a personal beneficiary, the standard structure is designed so the business is not a beneficiary under § 264(a)(1), but ownership and beneficiary designations are confirmed for each arrangement. Insurer forms, endorsements, procedures and timing vary from insurer to insurer and are confirmed with the insurers involved.
Parties Involved: Employer, Executive, and the Policy
Four parties appear in the typical arrangement.
- The employer. The business pays the bonus and may claim a compensation deduction. Section 162(a)(1) allows "a reasonable allowance for salaries or other compensation for personal services actually rendered," so the deduction attaches to pay for services.
- The executive. An employee, officer or director receives the bonus as income, owns the policy, is usually the insured, and names the beneficiary.
- The insurer. It issues the permanent policy to the executive as owner and insured.
- The beneficiary. Usually a family member, the beneficiary receives the death benefit when the insured dies.
Where an executive is also a shareholder, the pay draws closer attention. 26 C.F.R. § 1.162-7(b)(1) warns that in "a corporation having few shareholders, practically all of whom draw salaries," excessive payments that "bear a close relationship to the stockholdings" may be treated as a distribution of earnings rather than compensation.
Who This Is For: Businesses and Executives the Structure Typically Serves
The structure commonly appears in these situations:
- Closely held C corporations, S corporations, partnerships and LLCs that want a selective benefit for one or more key executives.
- Businesses looking for a benefit outside the coverage and nondiscrimination rules that govern qualified plans.
- Businesses that already sponsor a qualified plan and want an additional, separate benefit for selected people.
- Executives who value individually owned, portable life insurance as part of a compensation package.
- Owner-employees who are also executives, for whom the reasonableness of total compensation is a central question.
The arrangement is neither a qualified plan nor a deferred compensation arrangement. The executive receives the bonus currently as taxable income, so nothing is set aside for a later year.
When an Executive Bonus Plan May Fit
Fit usually turns on a handful of facts:
- The business wants to benefit specific executives rather than the whole workforce.
- The executive's total compensation, including the bonus, can be supported as reasonable. 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," provided that, added to salary, they "do not exceed a reasonable compensation."
- The executive is insurable, and the parties intend the executive to own the policy.
- The business prefers an arrangement that is administratively simpler than a qualified plan, with no separate funding trust for the basic version.
- Both sides accept that the bonus is taxed currently to the executive.
Whether the arrangement fits a particular business depends on facts this page does not have. Executive bonus deductibility and the reasonableness of compensation need individual review of the contracts involved, by the insurers and a qualified tax professional.
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When an Executive Bonus Plan May Not Fit
Some objectives point away from this structure:
- Employer control. The employer wants to own or control the policy or its cash value. In the standard arrangement the executive owns the policy outright, and a REBA restricts access without making the employer the owner.
- Unsupportable pay. The executive's total compensation cannot be supported as reasonable. Under 26 C.F.R. § 1.162-9, amounts "in excess of reasonable compensation for services, are not deductible."
- Employer as beneficiary. If the business is directly or indirectly a beneficiary, § 264(a)(1) provides that no deduction is allowed for the premiums.
- Tax deferral. The goal is to push the executive's tax into a future year. A bonus is income when received.
- Recovery on departure. The employer wants its cost back if the executive leaves. Without a REBA or similar agreement, the executive keeps the policy.
- Public company limits. A publicly held corporation faces a separate federal limit on deductible compensation for certain covered employees, which needs its own review.
Tax Treatment: How the Bonus and the Policy Are Taxed
Federal tax treatment has three parts.
Employer. Section 162(a) allows a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including (1) a reasonable allowance for salaries or other compensation for personal services actually rendered." 26 C.F.R. § 1.162-9 adds that "it is immaterial whether such bonuses are paid in cash or in kind." 26 C.F.R. § 1.162-7(a) states the test: "whether they are reasonable and are in fact payments purely for services." Section 264(a)(1) allows no deduction for premiums where the taxpayer "is directly or indirectly a beneficiary under the policy or contract," so where the executive owns the policy and names the beneficiary, the employer's deduction question is whether the bonus is reasonable compensation under § 162(a)(1).
Executive. Section 61(a) defines gross income to include "compensation for services, including fees, commissions, fringe benefits, and similar items." Premiums the employer pays directly are generally included under 26 C.F.R. § 1.61-2(d)(2)(ii)(A), which for a contract the employee owns, where the payments are not split-dollar loans, includes the employer's payments "to the extent that the employee's or independent contractor's rights to the life insurance contract are substantially vested." Withholding and employment-tax treatment of the bonus is confirmed with a tax professional.
Death benefit. Section 101(a)(1) generally excludes from gross income amounts paid "by reason of the death of the insured," subject to the transfer-for-value limit in § 101(a)(2) and, for employer-owned contracts, § 101(j), which caps the exclusion at premiums and other amounts paid unless a § 101(j)(2) exception applies and written notice and consent were given before issue. Section 101(j)(3)(A) defines an employer-owned life insurance contract as one "owned by a person engaged in a trade or business and under which such person (or a related person described in subparagraph (B)(ii)) is directly or indirectly a beneficiary under the contract" that covers an employee on the date the contract is issued. Where the executive owns the policy and names a personal beneficiary, the employer is neither owner nor beneficiary, but ownership, any later policy transfer and premium deductibility under § 264(a)(1) need individual review of the contracts involved, by the insurers and a qualified tax professional. The business life insurance tax treatment page covers these death-benefit rules.
Potential Advantages of the Arrangement
Businesses and executives commonly point to these features of the structure, none of which is a promised result:
- Selectivity. The employer chooses who receives the bonus; the coverage rules of qualified plans do not govern the bonus itself.
- Administration. A basic arrangement involves a bonus and an individually owned policy, without a plan trust. A REBA adds a separate restriction agreement.
- Portability. The executive owns the policy and can keep it when employment ends, subject to any REBA terms.
- Employer deduction. The bonus may be deductible to the extent it is reasonable compensation under § 162(a)(1) and 26 C.F.R. § 1.162-9.
- Individual coverage. The executive holds permanent life insurance with a death benefit payable to a personal beneficiary.
- Cash value. Permanent policies have a cash value feature, a contract value governed by the policy's own terms and charges, which vary by insurer.
Important Considerations: Risks and Limitations
Cost and tax fall on both sides. The bonus is taxable to the executive currently, with no deferral, and the executive bears the income tax on it unless a double bonus covers that tax. The employer bears the bonus and any gross-up.
Reasonableness is decided on facts and circumstances. 26 C.F.R. § 1.162-7(b)(3) states that reasonable compensation is generally "such amount as would ordinarily be paid for like services by like enterprises under like circumstances," judged by circumstances "existing at the date when the contract for services was made." Any excess is not deductible.
A REBA restriction is a contract. Its enforceability and its tax effect depend on how the agreement and any endorsement are drafted. Without one, the employer has no direct way to recover its cost if the executive leaves.
The policy pays the executive's family, not the business. Where the company also needs protection against losing that person, a separate employer-owned key person policy is a different arrangement with different rules. Policy features, charges and procedures vary by insurer, and insurance rules vary by state.
Tax and Legal Coordination: What Professionals Review
Several disciplines usually touch an arrangement before it begins:
- A tax professional or compensation counsel evaluates whether the bonus, combined with all other pay, is reasonable under § 162(a)(1) and 26 C.F.R. § 1.162-7.
- A tax professional confirms the employer's deduction and the executive's inclusion under § 61(a) and 26 C.F.R. § 1.61-2(d)(2)(ii)(A).
- Legal counsel drafts or reviews any REBA agreement for enforceability and tax treatment.
- For a publicly held corporation, advisers review the separate federal limit on deductible compensation for covered employees.
- Advisers review the death benefit's treatment under § 101(a)(1), the transfer-for-value rule in § 101(a)(2), and whether § 101(j) could apply to the contract as owned.
- Insurance professionals confirm policy ownership, beneficiary designations and endorsements, and that the paperwork matches the intended structure.
Each professional's conclusion depends on the facts presented.
Alternatives to Consider
Other structures address similar goals with different mechanics:
- Split-dollar life insurance. The employer and executive share premium, death benefit or cash value under a formal agreement, with tax treatment that depends on ownership and structure; Business Life Insurance covers split-dollar and its comparison with executive bonus plans on separate pages.
- Nonqualified deferred compensation. Pay is deferred to a future year under its own federal rules, with different tax timing.
- Key person life insurance. The employer owns the policy and is the beneficiary, so § 264(a)(1) allows no deduction for the premiums, and the death benefit is tested under § 101(j) if the contract meets that section's definition of an employer-owned life insurance contract.
- Section 412(e)(3) plan. A fully insured defined-benefit plan, formerly called a 412(i) plan, funded exclusively with individual insurance contracts and subject to the requirements of § 412(e)(3)(A) through (F).
How the roles fit together across these strategies is outlined in how business life insurance works.
Hypothetical Example: How the Numbers Flow
This example is hypothetical. Assumptions: the employer is a C corporation; the annual premium is $20,000; the executive's federal marginal rate is an assumed 37%, used only for illustration; state income tax, employment taxes and every other factor are ignored; and the bonus is treated as reasonable compensation.
Single bonus.
- Employer pays a $20,000 bonus.
- Executive includes $20,000 in gross income.
- Tax: $20,000 × 0.37 = $7,400.
- After tax: $20,000 − $7,400 = $12,600.
- Gap to premium: $20,000 − $12,600 = $7,400, which the executive funds from other money.
Double bonus (gross-up).
- Gross-up: $20,000 ÷ (1 − 0.37) = $20,000 ÷ 0.63 ≈ $31,746.
- Employer pays $31,746 and treats it as compensation.
- Tax: $31,746 × 0.37 ≈ $11,746.
- After tax: $31,746 − $11,746 = $20,000, equal to the premium.
The figures illustrate cash flow only. They are not any reader's result and are not a coverage recommendation.
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Frequently Asked Questions
How is an executive bonus plan taxed?
The bonus is generally gross income to the executive under 26 U.S.C. § 61(a) in the year received. The employer may deduct it under 26 U.S.C. § 162(a)(1) and 26 C.F.R. § 1.162-9 to the extent total compensation is reasonable for services actually rendered.
What is a restricted executive bonus arrangement (REBA)?
A REBA is an industry term, not a Code-defined term, for an executive bonus plan in which the terms agreed between employer and executive, and an endorsement placed on the policy, limit the executive's access to the policy values. It is used as a retention device, and its enforceability and tax effect depend on how the agreement is drafted.
What is a double bonus in an executive bonus plan?
A double bonus is an industry term for a variant in which the employer increases the bonus to cover the executive's income tax on it, so the after-tax amount equals the premium. The added amount is also compensation, included in the executive's income under § 61(a).
Is the death benefit from an executive bonus plan taxable?
Section 101(a)(1) generally excludes amounts paid by reason of the insured's death from gross income, subject to the transfer-for-value rule in § 101(a)(2) and, for employer-owned contracts, § 101(j). Section 101(j) applies to an employer-owned life insurance contract as the statute defines it, and where the executive owns the policy and names a personal beneficiary the employer is neither owner nor beneficiary, but ownership and beneficiary facts are confirmed for each contract.
Educational information only. Not legal, tax, investment or insurance advice. Product availability and outcomes depend on individual circumstances.