How to Structure a Bonus Plan

An executive bonus plan can do double duty, providing compensation and a performance incentive and reward for key employees.

Base it on clear objectives

As an incentive/reward, base bonuses on clear objectives that are tied to business goals – and individual achievements that support those goals. Employees should know what the performance standards are. They should know exactly what is expected and what the reward will be. And clearly stating the performance-based criteria in writing in advance could help you avoid a charge of excess compensation.

Think about shares as a reward

Consider rewarding employees with shares. That can be an effective way to transfer ownership of the business to employees. They might seek to buy the remaining shares from you when you are ready to sell the business.

Consider a life insurance policy

You might tie the bonus plan to a life insurance policy. Under Section 162 of the Internal Revenue Code, the business could receive a tax deduction. It would pay all or part of the premium on a policy owned by the key employee. The premium payments would be tax deductible to the business and taxable income to the key employee, under “other compensation.” The benefits to your employees include life insurance coverage at low cost or no cost, an income tax-free death benefit for their beneficiaries, and a potential source of retirement income.

Game Plan

  • Read about Section 162 executive bonus plans.
  • Consult your tax planner or accountant.
  • Talk with an attorney who specializes in employment and compensation.
  • Meet with an employee benefits consultant to explore what options might be most suitable for you.
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