Section 162 executive bonus plans, explained in plain English

An executive bonus plan is one of the simplest ways a business can give a key person a meaningful, lasting benefit — and take a tax deduction for doing it. It has a formal name, "Section 162 plan," which makes it sound more complicated than it is. Strip away the jargon and it is just a bonus, pointed at a life insurance policy the employee keeps.

Here is the whole thing in plain English.

The name comes from the tax code

Section 162 of the Internal Revenue Code is the provision that lets a business deduct "ordinary and necessary" business expenses — including reasonable compensation to employees. That is the entire reason the plan works: a bonus is compensation, and compensation is deductible.

So an executive bonus plan is nothing more than a bonus the business pays with a specific purpose in mind: funding a permanent life insurance policy that the key employee owns personally.

How the money moves

That fourth step is the wrinkle everyone asks about: the employee owes tax on money that went straight into a policy. Which is exactly why the "double bonus" exists.

Single bonus vs. double bonus

In a single bonus, the employer pays the premium and the employee pays the resulting tax themselves. In a double bonus, the employer pays an additional bonus sized to cover that tax, so the benefit lands in the employee's hands essentially tax-neutral. Both are deductible to the business. Which one you choose is a budget and messaging decision — there is more on the trade-off in single- vs. double-bonus plans.

Why owners use it

Three things make this structure attractive:

• It is deductible now. Unlike some deferred arrangements, the business gets its deduction in the year it pays the bonus.
• It is selective. You can offer it to one person or a chosen few. It does not carry the broad-coverage and nondiscrimination requirements that qualified retirement plans do, and it involves far less administrative machinery.
• The employee genuinely owns a real asset. A permanent policy builds cash value the employee can access later and a death benefit that generally passes income-tax-free to their beneficiary. That is a benefit people actually feel.

The retention gap — and how REBA closes it

The plain version has one limitation worth naming: because the employee owns everything immediately, nothing requires them to stay. If retention is the goal, a restricted version — a REBA — adds a vesting schedule through a restrictive endorsement, so the employee earns full access to the cash value only by staying. That is covered in adding vesting with a REBA.

The S-corporation owner trap

A few honest cautions

• The plan is built on permanent life insurance, which has costs, fees, and surrender charges, and is a long-term commitment. The cash value is not a guaranteed number; loans and withdrawals later reduce the death benefit and can have tax consequences.
• The deduction depends on the employee's total compensation being reasonable. A bonus that pushes pay past reasonable for the role can draw scrutiny.
• This is an insurance-and-compensation strategy, not tax advice. The mechanics above are general; the numbers and the entity details are a conversation for your tax and legal advisors.

Bottom line

A Section 162 executive bonus plan is a deductible bonus that leaves a key employee owning something real. It is simpler than deferred compensation, more flexible than a broad benefit plan, and — with a REBA layered on — can hold your best people in place. If you want to see how it would look for a specific role, the Section 162 strategy page goes deeper, and the design is worth coordinating with your accountant from the start.