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CFP Course 2 Flashcard Kaplan > Module 5 > Flashcards

Module 5 Flashcards

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1
Q

Qualified Plans (5)

A
  • Favorable Tax Treatment
  • Must be Funded
  • Minimum Participation and Nondiscrimination Requirements
  • Maximum Contribution and benefit limits
  • Employer gets tax deduction in the year in which they put the money in the plan
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2
Q

Annual Addition Limits for Contributions to defined contribution plans (from employers) (Qualified Plans)

A

$57,000 or 100% of Pay (combination of employer contributions and employee contributions)

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3
Q

Maximum Accrued Benefit Limit (Qualified Plans)

A

Maximum retirement income from a pension plan is $230,000 per year

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4
Q

Annual Compensation Limit (Qualified Plans)

A

How much of an employees income can be considered for a retirement plan calculation. If the company is planning to match 3% of income, it’s off of this number, even if someone is making more than $285,000.

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5
Q

Nonqualified Plan (6)

A
  • Any employer retirement, savings, or deferred compensation plan for employees that does not meet the IRC and ERISA requirements that apply to the qualified pensions and profit sharing plans
  • Designed to recruit, reward and retain key executives and other select employees
  • Employer deduction is available in the year of the employee taxation
  • tax deferred only if unfunded or funds are at risk; no rollovers
  • Earnings are currently taxable to employer
  • Taxed at ordinary rates; averaging not available on lump sums
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6
Q

Non Qualified Plan Three Principles for Deferred Compensation

A
  1. The agreement to defer compensation must be made before the dollars are earned (in the years prior or within 30 days of being offered)
  2. The agreement must represent only an unsecured promise
  3. The plan must be unfunded or, if funded, benefits must be nontransferable and subject to a substantial risk of forfeiture (and available to creditors)
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7
Q

Substantial Risk of Forfeiture

A
  1. An employees right to payments must be contingent upon future performance of substantial services (death or disability are not considered substantial services)
  2. Plan must provide for loss of rights to payments if substantial services are not performed of if employment terminated for reasons other than death or disability
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8
Q

Unfunded Plan

A
  • Mere promise made by the employer to pay benefits
  • Avoids current tax
  • Only subject to limited ERISA regulations (no disclosure or filing requirements under ERISA)
  • Provides little security for employee
  • “Top Hat” Plans - highly compensated employees
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9
Q

Informally Funded Plan

A
  • A “general reserve” is built to fund future plan obligations but reserve is subject to the companies creditors
  • Technically these are considered unfunded for purposes of ERISA because the assets are unsecured
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10
Q

Rabbi Trust

A

A trust set up with a independent financial institution for the purposes of the future payment of NQDO, as per the definition of a grantor trust, the trust earnings are currently taxable to the employer, rather than the employee.

  • Two Beneficiaries - the employee and the creditors of the company
  • Protected from future change of management of the company
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11
Q

Corporate Owned Life-Insurance (COLI)

A
  • Provides money to pay benefit at death
  • Accumulates cash value to pay benefit at retirement
  • Company owns the life insurance policy and be the beneficiary of the policy
  • tax-deferred and possibly tax-free, buildup of cash value
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12
Q

Funded Plans

A
  • Assets are set aside (beyond reach of mngmt and creditor) to fund deferred comp
  • Requires a substantial risk of forfeiture provision to avoid constructive receipt and current taxation benefits are taxed upon vesting
  • Subject to some ERISA regulations
  • Provides employees with greater confidence of future payments
  • Secular Trust
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13
Q

Secular Trust

A
  • Irrevocable fully funded trust established for an employee
  • If an employee is vested in contributions, the results is current taxation to employee
  • not subject to claims of creditors
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14
Q

Pure or Elective Nonqualified Plans

A

The Employee Chooses to defer compensations, to take less salary now and postpone it
- Salary Reduction Plan

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15
Q

Non-Elective (“Supplemental”) Non-qualified Plans

A

The employer funds the benefit and does not reduce the employee’s current compensation to fund future payments.

  • Excess Benefit Plans
  • SERP’s
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16
Q

Excess Benefit Plan

A
  • Linked indirectly to the qualified plan in place and provides for benefits in excess of the amount the employee would otherwise be entitled under the qualified plan
  • Payment will be made when the employee retires and paid out in the same way benefits are paid under a qualified retirement plan
  • May be funded, informally funded, or unfunded.
17
Q

Supplemental Executive Retirement Plan (SERP)

A
  • “Top Hat” Plan
  • unfunded plan providing benefits for select employees in excess of those provided by the employer’s qualified retirement plan (“Golden Handcuffs”)
  • SERP’s can be used for broader range of purposes than excess benefit plans
    - Golden Handcuffs
  • Unfunded SERP’s are exempt from all but the reporting and disclosure requirements of ERISA
18
Q

Constructive Receipt Doctorine

A
  • An amount is treated as received for tax purposes if credited to an employee account, set aside, or otherwise made available even if amount is not actually received.
19
Q

Economic Benefit Doctorine

A
  • Employees are taxed when plan accumulations are vested even though employees cannot yet withdraw cash.
20
Q

NQDC Tax Implications (employer)

A
  • Deduction when the money is taxed to the employee

- Earnings are taxed to the employer

21
Q

NQDC Tax Implications (Employee)

A
  • Taxed when benefit is constructively received

- Subject to FICA taxes when constructively received

22
Q

Section 409A - AJCA 2004

A
  • provides specific rules about allowing deferral of income, and prohibits arrangements that allow participants control of, or access to, deferred amounts.
  • Prohibiting accelerating distributions
  • Does not relate to qualified plans
23
Q

Deferral Requirements from Section 409A

A
  • Employees have 30 days after they first become eligible to participate in the plan to elect to make a deferral. thereafter, elections to defer compensation must occur in the year prior to the year in which the compensation was received
  • Performance period, within the first 6 months of the 12 months performance period
24
Q

Distribution Requirements Section 409A (8)

A

Can only be distributed due to:

  • seperation from service (at least 6 months after for Key Employees)
  • death
  • disability
  • Age, date or fixed schedule specified prior to first deferral
  • change of control or ownership in company
  • unforeseeable emergency
  • plan termination
  • Rabbi trusts cannot be offshore or contain financial triggers for benefit payment
25
Q

Noncompliance to 409A

A
  • immediate taxation for all deferred comp not subject to a substantial risk of forfeiture or previously included in income
  • interest assessed from the date of deferral at the underpayment rate plus 1% (you have to pay those taxes back)
  • AND an additional 20% penalty assessed on all amounts subject to taxation
  • If one plan fails to comply for a participant…all employer-sponsored plans of a similar type in which an individual participates will also fail
26
Q

Section 83(b) Election

A
  • Allows employee to recognize W-2 income immediately
  • If election is made within 30 days of receiving restricted stock:
    - EE includes as W-2 income FMV of stock upon receipt less any amount paid for the stock
  • Subsequent appreciation is treated as Cap Gains and may be taxed at lower Cap Gains rates when stock is sold.
  • Does not recognize any additional income until it’s sold, not when it’s vested
27
Q

Types of Stock Plans (6)

A
  • Incentive Stock Options (ISO)
  • Nonqualified Stock Options (NQSO)
  • Employee Stock Purchase Plans (ESPP)
  • Restricted Stock
  • Stock Appreciation Rights (SAR)
  • Phantom Stock
28
Q

Restricted Stock

A
  • Gives an executive the right to receive shares of stock at some point in the future if certain conditions are met (or when restrictions have been lifted).
  • this restricted period is called the “vesting period”
  • If sold to the executive at less than FMV, the executive receives an immediate economic benefit. There is no taxable income upon grant, current income when restriction period is up and if sold before 1 year then gain is taxed as current income.
  • shares can be forfeited
29
Q

Incentive Stock Options (ISO’)

A
  • Can only be offered to employees
  • Must be issued under a written plan approved by stockholders of the corporation
  • The option term and excersize period cannot exceed 10 years
  • The option price must equal or exceed the FMV of the stock at the time of the grant (if employee owns more than 10% of the company, option price must be 110% of FMV)
  • The options must expire no later than three months after employement is terminated
  • The option can only be excersized by the option holder and cannot be transferred, only at the death of the option holder
  • Only $100,000 of options may be granted annually based on the grant price
30
Q

ISO Tax Treatment

A
  • No income tax when ISO’s are granted
  • The difference between the Grant and Exercise price is AMT income in year of exercise (if stock is disposed of in same year as exercise, no AMT income.)
  • Income tax is not owed until the stock purchased with the ISO’s is sold
  • How the gain will be taxed depends on whether the disposition is a qualifying disposition or a disqualifying disposition (sold within 1 year of exercise AND 2 years from grant)
  • Employer ONLY gets a tax deduction if the employee takes the money before the holding period
31
Q

NonQualified Stock Option (NQSOs)

A
  • Employees and Non-employees
  • Exercise price must be equal or exceed the FMV at time of grant
  • Company can set the requirements for exercising the options
  • Company can determine the conditions under which the options are forfeited
  • No holding period rules apply
32
Q

Tax Treatment of NQSO

A
  • The options are not taxed when granted unless they have an ascertainable value
  • Upon exercise of the option (bargain element), the income is taxed as compensation (W-2 income)
  • The employer receives a deduction for the amount taxed to the option holder
  • Any change in value between the FMV at exercise and the disposition price is taxed as long- or short-term capital gain or loss.
33
Q

Employee Stock Purchase Plans (ESPPs)

A
  • $25,000 annual maximum
  • Share can be sold at up to a 15% discount
  • Same holding period requirements as ISO’s for capital gains treatment
34
Q

Restricted Stock Tax Considerations

A
  • Once the employee has been vested, we now have constructive receipt. At that point, the value of those shares are considered taxable W2 Compensation
  • Once taxable to the executive, it becomes deductible to the employer
  • Can make an 83(b) election, but if they make that election, and then the stock is forfeited, the EE is not allowed a deduction or a refund on the tax paid on previously reported income
35
Q

Stock Appreciation Rights (SAR’s)

A
  • ## Incentive compensation for closely held businesses (smaller companies, LLC’s or S-Corp’s)
36
Q

Phantom Stock

A
  • Used by closely held corporation
  • Fictional deferred compensation
  • Fictional entries track real appreciation of corporations common stock
  • Vesting - the employee won’t actually receive shares of stock, but will receive a lump sum payment of cash or cash equivalent. Value is going to be taxed as ordinary income when they are vested. Employer gets deduction
  • Drawbacks - not real shares, expensive for the employer
37
Q

Junior Class Shares

A
  • Separate class of common stock
  • Typically convertible into regular shares
  • Similar to NQSOs, but taxed more favorably.
38
Q

Junior Class Shares Taxation

A
  • There is no taxation the conversion to the common shares of the company, which is more favorable than the NQSO’s.
  • We just carry over our basis from the Junior Class shares, and when the employee sells those shares, it’s capital gains rates. Taxation is deferred until sell of shares

CFP Course 2 Flashcard Kaplan (5 decks)

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