Compared to qualified retirement plans, Section 162 executive bonus plans have remarkably few formal rules. There’s no IRS approval process, no minimum coverage requirements, and no nondiscrimination testing. But “few formal rules” doesn’t mean “no rules at all” — there are still eligibility considerations, practical limits, and structural requirements worth understanding before setting one up.

Who Can Be Included in the Plan

The business has broad discretion to decide who participates in a section 162 bonus plan. Unlike a 401(k) or other qualified plan, there’s no requirement to offer the benefit broadly across the workforce or satisfy nondiscrimination testing that compares benefits for highly compensated versus non-highly compensated employees. This means a business can select a single key executive, a small leadership team, or any group it chooses, without needing to justify that selection to the IRS the way it would for a qualified plan.

Can You Choose Just One Employee?

Yes. This is one of the most common questions business owners ask, and the answer is straightforward: a Section 162 plan can be set up for a single employee if that fits the business’s goal. There’s no minimum participation requirement. This flexibility is one of the strategy’s core advantages over qualified retirement plans, which generally must be offered more broadly to avoid running afoul of nondiscrimination rules.

Age and Health Considerations

While there’s no regulatory age limit on who can participate, practical underwriting considerations come into play, since the plan relies on the employee qualifying for life insurance coverage. Older employees or those with significant health conditions may face higher premiums or more limited underwriting outcomes, which affects the cost-effectiveness of the strategy and sometimes the choice of policy type. It’s worth discussing an employee’s age and general health picture with your provider early, before assuming a specific funding level or policy type will be available.

Income and Compensation Considerations

There’s no formal income threshold required to participate, but the bonus needs to be reasonable in relation to the employee’s overall compensation and role. A very large bonus layered onto a modest base salary, particularly for an owner-employee, can raise reasonable compensation concerns with the IRS. As a practical matter, most businesses use this strategy for employees whose base compensation already reflects a meaningful role at the company, with the bonus serving as an additional, proportionate benefit rather than the majority of their total pay.

Are There Contribution Limits?

Unlike qualified retirement plans, which impose annual contribution limits set by the IRS, there’s no statutory limit on how large a bonus can be under a Section 162 arrangement. The practical limit is really a function of what the business can reasonably afford to fund consistently, and what qualifies as reasonable compensation for the employee. This is part of why the strategy is popular for highly compensated employees who have already maxed out qualified plan contributions and want an additional benefit without a hard dollar cap.

Documentation Requirements

While there’s no IRS filing requirement, a properly structured plan should still include a written bonus agreement specifying the amount and terms of the bonus, board or ownership approval documenting the business decision, and, if the plan is restricted, a properly drafted restrictive endorsement filed with the insurance carrier. These aren’t legal requirements in the sense of a mandatory government filing, but they’re what support the plan’s tax treatment and provide clarity if questions arise later.

Entity-Specific Considerations

The core rules apply broadly across business structures, but the details of how the bonus flows through varies somewhat by entity type. C corporations, S corporations, partnerships, and sole proprietorships each have slightly different considerations, particularly around owner-employee participation and how the deduction interacts with the owner’s overall tax picture. This is an area where it’s worth a specific conversation with your CPA about your entity type before finalizing plan design.

The relative lack of formal rules is exactly what makes section 162 life insurance plans appealing to business owners who want flexibility, but that same flexibility puts more responsibility on the business to document the arrangement carefully and structure the bonus in a way that holds up to scrutiny.

Frequently Asked Questions

Is there a minimum number of employees required to set up a Section 162 plan?

No. A plan can be set up for a single employee, which is one of the key differences between this strategy and qualified retirement plans that typically require broader participation.

Do part-time employees qualify for a Section 162 plan?

There’s no legal restriction against including a part-time employee, but the business would need to determine that doing so makes sense given the employee’s compensation and the business’s retention or reward goals.

Is there an age limit for participating in a Section 162 plan?

There’s no regulatory age limit, but practical underwriting limits apply since the plan depends on the employee qualifying for a life insurance policy, and older applicants may face different pricing or underwriting outcomes.

Can an owner-employee participate in their own company’s Section 162 plan?

Yes, owner-employees can participate, though reasonable compensation considerations deserve extra attention in these cases to ensure total pay, including the bonus, is defensible as proportionate to the work performed.

Are there IRS filing requirements for a Section 162 plan?

No formal IRS filing or approval process is required, unlike qualified retirement plans. Proper payroll reporting and documentation of the bonus arrangement are what matter for tax compliance.

Can eligibility rules change after the plan is already set up?

Yes, the business retains discretion to add or adjust participants over time, since there’s no fixed eligibility structure required by regulation the way there is with a qualified plan.