The **Section 162 Executive Bonus Plan** is one of the simplest yet most effective ways for corporations to provide non-qualified benefits to key executives using permanent life insurance. Unlike complex Split-Dollar or Non-Qualified Deferred Compensation (NQDC) plans, a Section 162 plan is governed by a straightforward principle: the employer pays the premium for a life insurance policy owned by the employee, treating the payment as an annual, tax-deductible bonus. However, advanced planning utilizes variations—specifically the **Double Bonus** and the **Restricted Executive Bonus Arrangement (REBA)**—to strategically maximize the benefit for the employee while implementing corporate retention strategies.

I. Unrestricted Executive Bonus Plan (The Standard 162)

The standard 162 plan offers immediate ownership and full portability to the executive, acting as a simple, tax-efficient compensation tool.

1. Tax and Accounting Treatment

The premium payment is treated as current, taxable compensation to the employee but is fully tax-deductible to the employer under **IRC Section 162** (which covers deductible business expenses). The cash value grows tax-deferred, and the death benefit remains tax-free (assuming the policy is not a Modified Endowment Contract – MEC).

• **Employer:** Receives a full tax deduction for the premium payment.
• **Employee:** Pays ordinary income tax on the amount of the premium bonus in the year it is paid. The policy serves as a private, portable asset that the employee controls immediately.

2. Simplicity and Portability

The unrestricted plan is favored because it avoids complex regulatory compliance. Since the policy is owned by the employee and the employer has no financial interest (no loan, no collateral assignment), the policy is completely portable. If the executive leaves the company, the policy goes with them, and the company has no further obligation or claim on the cash value. This is a significant advantage over other retention-focused plans.

II. The Double Bonus Strategy (Gross-Up)

The single drawback of the standard 162 plan is that the premium payment is immediately taxable to the executive, forcing them to use personal funds or salary to cover the tax liability. The **Double Bonus** strategy eliminates this out-of-pocket tax burden.

1. The Mechanism of the Gross-Up

Under a Double Bonus plan, the employer pays **two** bonuses: **1) The Policy Premium Bonus** and **2) The Tax Bonus** (the cash amount needed to cover the executive’s tax liability resulting from both bonuses). The employer receives a tax deduction for the entire amount.

The calculation requires determining the total bonus amount ($B_T$) that, when taxed at the employee’s marginal rate ($T$), results in exactly enough net cash to cover the tax on $B_T$ plus the original premium ($P$).

$$ B_T = \frac{P}{1 – T} $$

Example: Assume the policy premium ($P$) is $\$50,000$ and the executive’s combined marginal tax rate ($T$) is $37\%$.

$$ B_T = \frac{\$50,000}{1 – 0.37} = \frac{\$50,000}{0.63} \approx \$79,365 $$

The employer bonuses $\$79,365$. The tax on this amount is $\$29,365$. The net amount to the employee is $\$50,000$, which covers the policy premium exactly. The employer deducts $\$79,365$, creating a highly efficient net cost structure. The executive benefits from a fully funded, non-tax-draining policy.

III. Restricted Executive Bonus Arrangement (REBA)

While the standard 162 plan is great for compensation, it fails as an executive retention tool because the policy is immediately portable. The **Restricted Executive Bonus Arrangement (REBA)** solves this by imposing vesting restrictions, creating the “Golden Handcuff.”

1. The Vesting Mechanism (IRC Section 83)

REBA is fundamentally governed by **IRC Section 83**, which deals with compensation paid in the form of property that is substantially non-vested.

In a REBA, the policy is still owned by the employee, but the employer places a restriction—typically in the form of a non-lapse endorsement or a formal collateral agreement—on the policy. This agreement states that if the executive leaves the company before a specific date (the vesting date), the executive must forfeit or return the cash value equal to the premiums paid by the company.

$$ \text{Retention Period} \rightarrow \text{Vesting Date} \rightarrow \text{Full Policy Control} $$

2. Taxation Under REBA

Under Section 83, the compensation (the premium bonus) is not taxed to the employee until it is **vested or transferable**.

This creates a period of tax deferral. The employee is only taxed when the restriction lapses (i.e., when they fulfill the service requirement).

The Tax Risk: When the restriction lapses, the amount taxable to the employee is the **fair market value** of the property (the policy’s cash value) at the vesting date, **not** just the cumulative premiums paid. If the cash value has grown significantly, the tax bill can be substantial. This large tax event may still require a simultaneous double bonus or gross-up at the time of vesting.

3. Strategic Use for Retention

The REBA is used to tie key employees to the company for a fixed period (e.g., 5 to 10 years). The policy serves as a substantial deferred bonus, only becoming fully accessible and portable if the service requirements are met. It aligns the executive’s long-term financial interest (a portable, high-cash-value policy) with the company’s need for retention.

IV. Comparative Analysis: 162 vs. Other Plans

| Feature | Section 162 (Unrestricted) | Restricted Bonus (REBA) | Split-Dollar (Loan Regime) |
| :— | :— | :— | :— |
| **Funding Status** | Taxable compensation | Tax deferred until vesting | Tax on imputed interest (AFR) |
| **Corporate Deduction** | Immediate (Year 1) | Immediate (Year 1) | No deduction (Treated as Loan) |
| **Executive Retention** | Low (Portable Day 1) | High (Golden Handcuff) | Medium (Loan repayment required) |
| **Tax Complexity** | Low (Simple Bonus) | High (IRC Sec. 83 & vesting) | Medium (IRC Sec. 7872 & AFR) |

Policy Selection and Funding Strategy

In all 162 plans, the policy selected (Whole Life, IUL, or VUL) should be heavily focused on **Cash Accumulation** rather than pure death benefit maximization. Since the policy’s purpose is retirement augmentation and executive benefit, it must be designed as a **Minimum Death Benefit (CVAT or GPT)**, high-premium contract (often designed to be “non-MEC”) to ensure the maximum internal rate of return (IRR) on the cash value.

V. Fiduciary Due Diligence

For fiduciaries implementing 162 plans, especially REBA, meticulous attention must be paid to documentation:

• **Formal Agreement:** The terms of the bonus, vesting schedule, and repayment obligations must be clearly documented in a formal plan agreement between the company and the executive.
• **Tax Reporting:** The employer must properly issue a **Form W-2** (reporting the premium as taxable income) for the standard 162 plan, or follow strict Section 83 reporting guidelines for the REBA, ensuring proper valuation at the time of vesting.
• **Policy Drafting:** The policy itself must contain the formal endorsement or restrictive rider required for REBA, giving the employer the right to recover cash value if separation occurs before vesting.

The Section 162 plan, particularly when enhanced by the Double Bonus and REBA structures, remains a fundamental tool for rewarding and retaining top talent by providing access to a unique, tax-advantaged private asset.

Disclaimer: This content is for informational purposes only and does not constitute legal, tax, or compensation advice. The application of IRC Section 83 and executive compensation laws requires consultation with specialized legal and tax counsel.