Chapter 12 - Deferred Compensation and Nonqualified Plans

Question 1

Nonqualified Deferred compensation plan

Answer 1

Can discriminate to key employees in the event qualified plans can’t provide enough resources for key executive that earn over $330,000
No tax advantages of qualified plans

Question 2

NQDC funding type

Answer 2

funded/unfunded

Question 3

Unfunded NQDC

Answer 3

Promise to pay
Funds not formally set aside
no constructive receipt
Risk of forfeiture
meets requirements for tax deferral

Question 4

Funded NQDC

Answer 4

Assets put in trust
Must have risk of forfeiture to avoid taxation
-secular trust
-Rabbi trust

Question 5

NQDC employer advantages

Answer 5

Current outflow deferred
Pay payroll tax now but not at time of future payout

Question 6

NQDC Executive advantages

Answer 6

Reduced taxable income
Pay payroll tax now but not at time of future payout

Question 7

Secular Trust

Answer 7

Irrevocable trust that hold set aside funds of a NQDC.
Not available to employer or employer’s creditors
Not usually substantial risk of forfeiture but may have vesting period

Question 8

Rabbi Trust

Answer 8

Irrevocable trust to hold set-aside funds of NQDC
Funds not available to employer but may be available to employer’s creditors

Question 9

Phantom stock plan

Answer 9

Employer gives fictional shares to key executives.
Stock is valued at later date and executive will receive the increase in value as compensation.
No actual stock issued so no taxable income
Employer has deduction at time of payment

Question 10

Supplemental Executive Retirement Plans

Answer 10

Top-hat plans
Provide additional benefits to an executive during retirement and may be funded or non funded

Question 11

Salary reduction plans

Answer 11

Executive defers receipt of salary to the future and must elect to defer compensation before earning the salary

Question 12

401k wrap plan

Answer 12

Allows executives who maximize allowable 401k deferral to defer additional salary into NQDC plan

Question 13

Risk of forfeiture

Answer 13

Without substantial risk of forfeiture the value of the trust is taxable to the executive at the time it’s funded

Question 14

Deferred compensation executive tax benefits

Answer 14

Allow for deferral of taxable income to the future when the executive’s marginal tax rate is lower

Question 15

Deferred compensation employer tax benefits

Answer 15

Avoid $1,000,000 tax deductible compensation limit

Question 16

Deferred compensation income tax

Answer 16

Payroll tax must still be paid
Employer income tax deferred until paid out to employee
Employee deferral of income tax recognition - ordinary income when finally paid out, no additional payroll tax, employer will take corresponding tax deduction

Question 17

Constructive receipt

Answer 17

Established when income is included in a taxpayer’s taxable income. Income is constructively received when funds are not subject to limitations or restrictions

Question 18

Economic benefit doctrine

Answer 18

Employee will be taxed on funds if the funds are unrestricted and nonforfeitable

Question 19

Payroll tax

Answer 19

Deferred compensation is subject to payroll tax at the time income is earned
Usually only 1.45% for medicare portion. Executives with salaries greater than $147,000 are the ones contributing to plan

Question 20

3 types of stock options

Answer 20

Incentive stock option
Nonqualified stock option
Stock appreciation rights

Question 21

Incentive stock option

Answer 21

Grant - no tax
Exercise - no ordinary income (AMT preference item)
Sale - If held for 2 years from grant and 1 year from exercise LTCG otherwise ordinary income
Each year less than $100,000 exercisable per executive

Question 22

Nonqualified stock option

Answer 22

Grant - If strike is >= FMV no tax
Exercise - Ordinary income (employer has deduction for same amount) FMV - Exercise price
Sale - LTG or STG depending on holding period
Basis FMV at date of exercise

Question 23

Gifting of stock options

Answer 23

ISOs cannot be gifted
NQSO may be gifted - on exercise the employee will pay ordinary income and employer will receive tax deduction. Donee will pay for exercise and new basis will be FMV at date of exercise.

Question 24

Stock appreciation rights

Answer 24

Grant the holder cash in the amount equal to the excess of the FMV of the stock over the exercise price - cashless exercise without the right to buy the stock
No taxation at grant
Employee W2 income for value of exercise price
Employer tax deduction for W2 amount

Question 25

Restricted stock

Answer 25

At receipt there is no taxable income/deduction.
At time restriction is lifted there is W2 income for the FMV of the stock at that time and employer has deduction equal to W2 amount
Holding period begins date restriction is lifted

Question 26

Employee stock purchase plan

Answer 26

Allows employee to purchase shares at a discounted price and receive favorable tax treatment on sale.
Discounted price is no less than 85% of date determined stock price or an average stock price.
Purchase limit of $25,000 per year.
Holding period 2 years from grant or 1 year from exercise
Partially ordinary income - gain from discount
LTCG - excess of ordinary income

Question 27

ESPP disqualifying disposition

Answer 27

W2 income - gain from discount
LTCG or STCG in excess of W2 income - holding period begins on exercise date

Question 28

IRC Section 83b

Answer 28

Employee may elect to include the value of stock in taxable income at the date of the grant rather than at the date of vesting. Any gain over grant date is capital gain rather than W2 income.