Restricted bonus plans funded with life insurance offer a hybrid arrangement that bridges the gap between a deferred comp plan and regular executive bonus plan for non-owner key executives. An employer may like the benefit control afforded by a deferred comp plan (corporate owned insurance policy and a vesting schedule in the legal agreement), but object to the non-deductibility of the deferred amounts for corporate tax-accounting purposes. Also, the employer may object to the booking of the deferred comp liability on the corporate balance sheet for generally accepted accounting and FASB purposes.
Conversely, a regular executive bonus plan provides a deduction to the corporation (IRC Section 162), but the corporation has no control over the bonus once it is paid to the executive (personally owned insurance policy). And the executive can leave the employer for other employment at any time with no loss of benefits on the bonuses already received.
The “restricted bonus plan” gives the corporation a current deduction PLUS control of the benefit provided in the form of forfeiture language in a restricted bonus legal agreement. If the executive leaves the employer for other employment prior to full vesting according to the written agreement, the executive may lose some or all of the benefits provided.
PLAN DESIGN FEATURES AND TAXATION
· A legal agreement where the employer agrees to pay an annual bonus subject to partial or full forfeiture of cumulative bonuses if the employee terminates employment during the vesting period. A forfeiture during the vesting period would require the executive to reimburse some amount of the cumulative bonuses back to the corporation. The corporation would have to declare any reimbursements as taxable corporate income
· Bonuses are used to pay premiums for a personally owned policy. Premiums are paid from the issue age to the age of retirement only.
· The corporation may provide an “extra bonus” for taxes due so that the after-tax amount is equal to the annual premium (40% tax bracket … $20,000 bonus … nets $12,000 premium after taxes)
· The insurance proposal can show a tax-free solve income stream from policy cash value via withdrawals to basis, then switching to loans (FIFO). For example, the tax-free policy income stream may be shown from retirement age of 65 to age 85. It’s best to use a life insurance contract that emphasizes cash value accumulation and efficient cash distribution
· The death benefit remains income tax free to the insured executive’s personal beneficiary.
· The plan is especially attractive in an S Corporation case. Since an S Corp is a “pass-through” entity to the business owner for tax purposes, the non-deductible deferrals of a deferred comp plan would flow through as personal taxable income to the S Corp owner (S Corp K-1). In essence, the S Corp owner would be using his own personal after-tax dollars to fund the deferred comp benefit of the non-owner key executive. The restricted bonus plan avoids this tax accounting problem
· The bonuses are deductible to the corporation and fully taxable to the executive as compensation. Since the benefits of the restricted bonus plan are subject to a risk of forfeiture if the executive terminates employment during the vesting period, the executive can make a Section 83(b) election to have the bonuses taxed currently despite the risk of forfeiture.