Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company1 An addition to regular salary or compensation

Copyright 2011, The National Underwriter Company

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Bonus Plan Chapter 32Employee Benefit & Retirement Planning

An addition to regular salary or compensation that is provided, usually near year end, to enable employees to share in the profits of a successful year.

What is it?


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• to enable shareholder-employees in closely held companies to withdraw maximum compensation income from the company each year

• to provide executives of larger corporations an incentive-oriented compensation based on attaining profit or other goals during year

• to assist executives in funding cross-purchase buy-sell agreement or in contributing their share of premium in split-dollar arrangement

When is it indicated?


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• provides effective incentive-based form of compensation

• allows compensation to reflect company performance in closely held and larger corporations

• flexible and simple to design

Advantages


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• no opportunity for employee to defer taxation of compensation for more than one year

• tax deduction for employer limited by ‘reasonableness’ requirement

• bonuses taxable to employee as ordinary income

Disadvantages


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• a bonus cannot be deducted unless it constitutes a reasonable allowance for services actually rendered

• no deduction permitted for compensation >$1,000,000 paid to certain top executives of publicly held corporations

Tax Implications


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• bonuses CAN be large IF based on profits or earnings and the company has a very good year– reasonableness of compensation often tested in accord

with circumstances existing when entered bonus agreement vs. when bonus paid

– IRS and courts consider the risk faced by employee

Tax Implications


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• plan ahead when using bonuses as employee compensation to be able to defend ‘reasonableness’ of compensation

• 2½ month safe harbor rulean accrual method corporation can deduct a compensation payment that is properly accrued before the end of a given year, so long as the payment is made no later than 2½ months after the end of the corporation’s taxable year

Tax Implications


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• regular employees can use the 2½ month safe harbor technique to move taxable income to the employee’s next taxable year

e.g. corporation deducts bonus earned in 2011, bonus paid to employee on March 15, 2012; employee can defer tax payment to April 15, 2013 (employee’s due date for 2012 tax return)

Tax Implications


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1. can avoid or defer tax with noncash compensation plans, e.g.– qualified pension and profit sharing plans– nonqualified deferred compensation plans– medical benefit plans

2. stock-based plans also offer performance-based incentive– stock optoin– incentive stock option (ISO)– restricted stock plans

Alternatives


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• can be informal, even oral!

• no tax or legal requirement for written plan or for filing anything with the government

• best if employer and employee develop written plan in consult with an attorney

How are these plans set up?


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1. A bonus is considered part of regular salary.

2. The only reason to use a bonus is to create a performance incentive.

3. Bonus arrangements are simple because they face no tax constraints other than their treatment as ordinary income.

True or False?


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4. The ‘reasonableness of compensation’ rule effectively limits all bonuses to all types of employees to only a small percentage of usual compensation.

5. A bonus plan must be written.

True or False?


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What are the advantages of having a written bonus plan?

Discussion Question

Documents

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company1 An addition to regular salary or compensation