Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company1 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?

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company2 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?

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company3 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

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company4 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

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company5 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

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company6 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

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company7 plan ahead when using bonuses as employee compensation to be able to defend ‘reasonableness’ of compensation 2½ month safe harbor rule 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 2½ months after the end of the corporation’s taxable year Tax Implications

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company8 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 2009, bonus paid to employee on March 15, 2010; employee can defer tax payment to April 15, 2010 Tax Implications

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company9 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

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company10 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?

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company11 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?

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company12 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?

Bonus Plan Chapter 32 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company13 What are the advantages of having a written bonus plan? Discussion Question