Getting More for Your Bonus 

One of the challenges with cash based bonuses is that the effect of the bonus is often short-lived. The employee receives the bonus, spends it, and forgets about it until they're potentially eligible for another one the next year.

A way for employers to put more teeth to the plan is to direct the expenditure of the bonus to a tax-advantaged financial contract. A popular incentive technique, often referred to as "executive bonus," is to have the employer pay the premium for a permanent life insurance policy on the key employee's life. The employee would be the owner of the policy and designate the beneficiary. The policy effectively becomes a self-completing financial vehicle in that whether the employee dies prematurely or lives to retirement, a benefit is paid.

If the employee dies while still working, his or her family receives a tax-free death benefit. If the employee survives to retirement, the cash values of the permanent life insurance policy represent a potential source of additional retirement capital, to provide tax-advantaged distributions.

Although the employer can have no beneficial interest in the policy, it is possible to design it in a way to assure that the policy is not surrendered, pledged or borrowed upon without the employer's consent. By establishing an employment contract with the employee and notifying the life insurance company, the employer can, for a designated period of time, have the right to sign off on several major decisions the employee may make with respect to the life insurance policy.

Establishing an executive bonus plan of this nature involves attention to detail beyond the scope of this article, but these plans have proven a popular way for employers to provide an incentive plan for key employees that have lasting and beneficial advantages for both the employee and the business sponsoring the plan.

Making it Happen This Year

So, let's marry the features of this new revenue ruling with the well-known executive bonus plan structure.

The idea would be to currently set up a budget for the executive bonus plan and thereby be able to deduct the budgeted premiums for this tax year. The final tally of which employees are covered and how much of the budget will be allocated to each employee's policy will be determined and paid by March 15 of the next year. This also allows some time for the employer's insurance broker to submit applications and begin the underwriting process on the life insurance policies.

Time is limited, and it is important to get sound legal, tax and insurance advice. But this new revenue ruling offers employers a way to establish a deductible bonus plan this year while working out the details, and paying for the plan, early next year.