More on Tax Situations

Employer's Tax Situation

Deduction for Bonus or Premiums

Generally speaking, an employer can deduct compensation paid to an employee (regardless of the form) as long as compensation is "reasonable" in the aggregate.

But more care is required if the employer pays premiums on an employee-owned policy directly to the insurance company. Here, the deduction is allowed only if all of the following conditions are met:

• The employer is not a beneficiary of the policy, directly or indirectly.
• Salary or bonus used to pay premiums represents an ordinary and necessary business expense of the employer.
• If the insured employee is also a shareholder in the employer, the premium must not be construed as a constructive dividend to the shareholder-employee.
• The employee's total compensation package is reasonable in view of the services rendered to the employer.
• The employer must pay the employer's share of FICA and Medicare taxes on bonused amounts.

Corporate Alternative Minimum Tax

Since the policy is owned by the employee and not the corporation, there will be no problem with the corporate alternative minimum tax (AMT). No proceeds ever pour into the corporation that could result in a preference item potentially subject to the AMT.

Employee's Tax Situation

Tax Leverage for Shareholder-Employees

In some cases it could be cheaper for income to be taxed to the shareholder rather than to the corporation, because the individual is in a lower marginal tax bracket than the business.

Estate Tax Considerations

The death proceeds of the executive bonus policy are usually includible in the insured employee's gross estate at death because he or she owned the policy.

Double Bonus

In addition to the bonus of an amount sufficient to pay the annual premium, the employer may bonus out an additional amount—a "double bonus"—to pay the tax on the bonus itself, including that on the additional bonus!

The employee must pay the employee's share of FICA and Medicare taxes on bonused amounts.