An employer pays the premiums on a life insurance policy owned by a key employee, and the premium amount is treated as additional taxable compensation to that employee. This arrangement is called a(n):
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Why A is correct
An executive bonus plan (also called a Section 162 plan) is an arrangement in which the employer pays the premiums on a life insurance policy owned by the employee. Because the employee owns the policy, the employee controls the beneficiary designation and the cash value, and the premium payments are treated as taxable income to the employee. The employer generally deducts the premiums as compensation, which is why the plan is sometimes called a Section 162 bonus plan. The key distinguishing feature is that the employee owns the policy outright, not the employer.
Why the other options are wrong
- Split-dollar involves the employer and employee sharing premium payments and policy benefits under a written agreement; it does not treat the entire premium as taxable compensation to the employee, and the employee's ownership interest differs fundamentally from outright ownership.
- Key person insurance is owned by the employer, with the employer as the named beneficiary, to indemnify the business for the financial loss caused by the death of a critical employee. It does not provide an employee-owned benefit.
- Deferred compensation is a future income promise funded by a policy that the employer owns; the employee is not the policyowner and receives no current taxable premium income under the arrangement.
Memory hook
Bonus plan means the employee owns the policy and the employer pays the premiums as taxable pay.