At small companies, the risk of running afoul of IRS rules often squelches efforts to enhance executive benefits. Quaker Fabric, an upholstery maker in Fall River, Mass., found a solution by supplementing its life-insurance program with a "group carve-out" plan for eight key employees.

A carve-out plan augments a selected employee's basic life-insurance package, adding, for example, coverage equal to the employee's gross annual salary. "At large corporations fringe benefits are an important part of executive compensation," says Cynthia Gordan, Quaker Fabric's vice-president and general counsel. "When I came to this company, I suggested that we set up a group carve-out plan because I felt it was affordable and would provide an important level of benefit."

Group carve-out programs incur some tax hits. The IRS permits the cost of policies with up to $50,000 in coverage to be deducted as a business expense (if the policies remain as group term life) but for coverage greater than that, carve-out costs are nondeductible, and the employees who receive the extra coverage must pay income tax on the benefit.

For example, in a 20-person company that gives every employee life-insurance coverage of $50,000, an executive, age 55, gets an extra $100,000 in coverage and so owes tax on $900 in imputed income for the year. "The IRS lets carve-out participants rely on their insurance company's actuarial tables when assessing imputed income, which keeps tax payments relatively low," says Janet Reardon, a specialist at The New England insurance company in Boston.

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