Did you know that the actual value of a bonus, in the form of a fringe benefit, is reduced when an employee is required to pay income taxes on it? Because of taxation, many companies pay the fringe benefit (the bonus), plus additional funds to pay the income tax on the benefit. This is commonly referred to as a “double bonus.”
Consider the following scenario. A corporation purchases a life insurance policy on the life of one of its key executives. The insurance premium is $6,500, which the corporation will give to the executive as a bonus. The executive’s combined Federal and state income tax rate is 41% (35% Federal and 6% state); so, the tax on the $6,500 would be $2,665, leaving only $3,835 with which to pay the life insurance premium.
How much more will the corporation need to provide to allow the executive to pay both the life insurance premium and the tax on the premium? The amount can be calculated by dividing the $6,500 by 1 minus .41 (the executive’s tax rate), in this case dividing $6,500 by 0.59 for a total of $11,016.95. The company could choose to give this amount as a bonus to the executive, who would then be left with $6,500 after taxes to pay the insurance premium.