Ask the Experts!
The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.
Question: I have a couple of clients who own a business as 50-50 partners. They want to set up a cross purchase buy-sell agreement funded by the business, with premium to be paid under a bonus arrangement. The partners are different ages, so one policy is $1,200 per month while the other’s is $3,600. How do they determine how much to have the business pay them extra if they want the bonus to have zero personal cost?
Answer: If the business pays your clients the extra $1,200 and $3,600, they will have ordinary income that is taxed at their respective tax brackets. If each client is in the 25% tax bracket, they will incur $400 (25% of $1,200) and $900 (25% of $3,600) of personal income taxes respectively. If the business pays these taxes, then each partner has an additional $400 and $900 of income, which will also incur taxes—and so on.
To determine the amount of bonus needed to cover both the premium and the tax on the bonus, your clients can use the following formula:
Bonus = cost of insurance / (1 – tax rate)
This is often referred to as the gross-up or double bonus. Using the example from above, the business will pay the first partner $1,600 (i.e. $1,200/.75), and the second partner $4,800 (i.e. $3,600/.75). The first partner will use $1,200 of the bonus to pay the premium, and the other $400 from the bonus to cover his tax liability.
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