Is an Executive Bonus Plan Tax-Deductible for the Employer?

Technical Summary: How the Deduction Works

An employer's deduction for an executive bonus is allowed as compensation, not as an insurance premium, and only when the executive's total pay is reasonable and is paid for services actually rendered. The executive owns the policy, and the employer is not its beneficiary.

The question usually comes from owners, chief financial officers and finance leads of closely held companies. They want to reward or retain a key executive, and they are deciding whether life insurance can fund that benefit through ordinary payroll. This page treats the policy as a funding mechanism inside a compensation plan, not as the plan itself.

Two federal rules frame the answer. 26 U.S.C. § 162(a)(1) allows a deduction for "a reasonable allowance for salaries or other compensation for personal services actually rendered." 26 U.S.C. § 264(a)(1) denies any deduction for life insurance premiums "if the taxpayer is directly or indirectly a beneficiary under the policy." In an executive bonus arrangement, the employer pays compensation, and the executive pays the premium on a policy the executive owns.

This page covers the employer's deduction only. The executive's income inclusion and the death benefit's treatment belong to the site's page on executive bonus plan tax treatment.

The Arrangement Behind the Deduction Question

At its core, the arrangement is extra pay that funds insurance. The business problem is attracting or keeping a valued executive. The employer wants to provide that person with life insurance protection without the business owning a policy.

"Executive bonus plan," "section 162 plan" and "double bonus" are industry labels. None is a qualified plan, and none is defined in the Internal Revenue Code or Treasury Regulations. The mechanics usually run as follows:

• Owner: the executive, or a person the executive chooses, owns the policy from issue.
• Premium payer: the executive pays the premium, using a bonus the employer pays as compensation.
• Beneficiary: the executive names a personal beneficiary, not the employer.
• Proceeds: a death benefit goes to the executive's chosen beneficiary. The executive controls cash value, which is a contract feature of some policies.

A restricted executive bonus arrangement (REBA), also an industry label rather than a Code term, adds an agreement limiting the executive's access to cash value. The site's overview of executive bonus plans describes the arrangement more fully.

Applicable Rules: Section 162 and Section 264

The Code's general deduction rule comes first. 26 U.S.C. § 162(a) provides that "there shall be allowed as a deduction 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."

The regulations refine that rule. 26 C.F.R. § 1.162-7(b)(1) states that "any amount paid in the form of compensation, but not in fact as the purchase price of services, is not deductible." Section 1.162-7(b)(3) adds that "[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." Bonuses are addressed in 26 C.F.R. § 1.162-9, which allows them when "made in good faith and as additional compensation for the services actually rendered."

The premium bar sits alongside these rules. 26 U.S.C. § 264(a)(1) denies a deduction for "premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary." 26 C.F.R. § 1.264-1(a) applies this to policies covering "any officer or employee of the taxpayer, or any person (including the taxpayer) who is financially interested" in the business. The bar applies "even though they would otherwise be deductible as trade or business expenses." Because the employer in an executive bonus arrangement neither owns the policy nor stands to receive its proceeds, the arrangement is designed to sit outside this bar. The same bar is why key person insurance premiums usually are not deductible.

For publicly held corporations, 26 U.S.C. § 162(m)(1) denies a deduction for a covered employee's applicable remuneration above $1,000,000 for the taxable year, as stated in the 2024 edition of the Code. That limit applies to a "publicly held corporation" as § 162(m)(2) defines the term: an issuer whose securities are required to be registered under section 12 of the Securities Exchange Act of 1934, or that is required to file reports under section 15(d) of that Act.

Requirements for the Deduction

Each condition comes from the text of the rules.

1. Compensation for services. The payment is compensation "for personal services actually rendered" (26 U.S.C. § 162(a)(1); 26 C.F.R. § 1.162-7(a)).
2. Reasonable amount. The amount does not exceed what is reasonable under all the circumstances. The regulation's general assumption is that reasonable compensation is "only such amount as would ordinarily be paid for like services by like enterprises under like circumstances," judged as of the date the contract for services was made (26 C.F.R. § 1.162-7(b)(3)).
3. Paid to an employee. 26 C.F.R. § 1.162-9 addresses bonuses to employees, paid in good faith as additional compensation.
4. No beneficial interest for the employer. The employer is not "directly or indirectly a beneficiary" of the policy (26 U.S.C. § 264(a)(1)). Under 26 C.F.R. § 1.264-1(b), a taxpayer that takes out a policy "for the purpose of protecting himself from loss in the event of the death of the insured" is treated as a beneficiary.
5. Timing. The expense must be "paid or incurred during the taxable year" (26 U.S.C. § 162(a)).

Executive bonus deductibility, the reasonableness of compensation, and whether the employer holds any direct or indirect beneficial interest in the policy under section 264(a)(1) all require individual review of the contracts and facts by the insurers involved and a qualified tax professional.

How the Rules Work in Practice

In practice, the arrangement is a sequence of ordinary payroll steps.

1. The employer sets the bonus amount, typically sized to the premium the executive will pay.
2. The employer pays the bonus as additional compensation. This payment is the amount the employer seeks to deduct under 26 U.S.C. § 162(a)(1).
3. The executive receives the bonus as compensation and pays the premium on a policy the executive owns.
4. Because the employer is not a beneficiary, the section 264(a)(1) premium bar does not reach the employer's compensation payment.

In a "double bonus," the employer pays a second bonus meant to cover the executive's income tax on the first. Neither bonus has a separate test. 26 C.F.R. § 1.162-9 asks whether bonuses, "when added to the stipulated salaries," exceed reasonable compensation. That means salary, the premium bonus and any second bonus are measured together.

Policy forms, premium amounts and policy terms vary from insurer to insurer and are confirmed with the insurers involved.

Who This Arrangement Is For

Most users are closely held businesses. Typical examples are C corporations, S corporations, partnerships and professional practices that want to provide a chosen executive with life insurance funded by the business.

The business pays compensation, which § 162(a)(1) tests for reasonableness, rather than a premium on a policy of which it is a beneficiary, which § 264(a)(1) does not allow it to deduct. The arrangement can cover one executive or a small group.

The executives involved are often owner-employees, key employees or highly compensated employees the business hopes to retain. Whether the arrangement fits a particular business depends on its compensation history, ownership, cash flow and the executive's role.