Executive Bonus Plan

Occasionally, an executive’s employment contract or other business agreement may specify the amount and timing of any cash bonus to be paid through an employee bonus plan.

 

Although a bonus is taxable to the employee as additional compensation, it can be used to meet a specific financial objective or need. Proper planning can reduce the adverse tax consequences. A bonus is deductible by the corporation as long as the employee's total compensation, including the bonus, is reasonable.  

 

A bonus paid to a shareholder-employee may be viewed by the IRS as a dividend distribution rather than as additional compensation. If this does happen, the shareholder-employee is subject to income tax on the dividend, but the dividend is not deductible by the corporation.

 

The risk of such treatment is especially high when the amount and timing of a bonus are set at the end of the corporate tax year rather than according to a pre-established plan.

 

Since bonuses are often payable after the end of the year in which they are earned (because they are based upon company performance for that year) the "2 ½ month safe-harbor rule" is important. This rule provides that an 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 2 ½ months after the end of the corporation's taxable year. The 2 ½ month rule does not apply to payments to employees who own or control the corporation (i.e. own 50% or more of the corporation). For those controlling shareholder-employees, the corporation can only deduct the payment in the taxable year in which it is actually paid.

 

 

 

 

This is a FREE service to you.

Why PlannerConnect? Create A Financial Plan