Planning for Executives - 4 Different types of executive deferred compensation plans

Question 1

What is a Stock Option?

Answer 1

Right to buy a certain number of shares at a specified price

Question 2

What are the two reasons why companies issue Stock Options?

Answer 2

1) Start-ups are frequently cash strapped and don’t need immediate
compensation deductions

2) To attract/retain employees and align interests

Question 3

What are the two types of Stock Options?

Answer 3

1) Non-Qualified Stock Options (NSO)
2) Incentive Stock Options (ISO)

Question 4

What do NSOs and ISOs do?

Answer 4

Both ISOs and NSOs give the option holder a right to purchase shares of stock at the stated exercise price that is of value only if the shares of underlying stock subject to the option increase in value

Question 5

What are the similarities between NSOs and ISOs?

Answer 5

1) No tax impact at grant or vest
2) Sec. 83b election available with early exercise

Question 6

What do NSOs do that ISOs do not?

Answer 6

1) Spread at exercise is compensation subject to payroll taxes
2) At exercise, employee needs to raise exercise price and withholding.
*“Cashless Exercise”
3) On disposition, post-exercise appreciation is capital gain

Question 7

What do ISOs do that NSOs do not?

Answer 7

1) No ordinary income at exercise
2) Spread at exercise is AMT preference
* Leads to basis differential
3) Depending on AMT, may be able to exercise tax-free
4) On disposition of stock, long-term capital gain if:
* Held for 2 years from grant, AND
* Held for 1 year from exercise
5) Disqualifying Disposition triggers compensation income (not subject to payroll tax or withholding) equal to the lesserof spread at exercise or gain realized with balance treated as capital gain

Question 8

What is California Stock Option Taxation?

Answer 8

• Heads they win, tails you lose!!!
• Departing Resident: CA applies accrual method.
• Incoming Resident: CA applies cash method.

Question 9

What is Sec. 83(i)?

Answer 9

• New for 2018
  Employees can elect to defer income from ISO exercise
• Income still measured by value at exercise
• ISO spread treated as compensation income
  Applies only for income tax, NSO rules apply for payroll tax purposes
  Election cannot be combined with 83(b) election
  Eligible Corporation requirements
  Multiple issues limit likely popularity

Question 10

What are some examples of different types fo executive deferred compensation plans?

Answer 10

409A Plans and ESPPs

Question 11

What are qualified deferred compensation plans?

Answer 11

This plan allows employees to defer compensation and taxes currently to
be withdrawn and taxed at a later date, subject to IRS limits

Question 12

What are Non-qualified deferred compensation (NQDC) plans?

Answer 12

It provides highly compensated employees to defer additional
amounts above the IRS limits

Question 13

For the 409A Plan, Irrevocable elections for deferral amount and distribution must be made in year ______ to compensation earned

(prior or after)

Answer 13

prior

Question 14

What are benefits for the 409A Plan?

Answer 14

1) deferred compounding on a larger (pre-tax) amount
2) tax rate arbitrage

Question 15

What are plans not subject to qualified deferred compensation (DC) requirements?

Answer 15

fiduciary, IRS filing, nondiscrimination, funding, vesting, reporting, etc.

Question 16

Do NQDC plans receive ERISA protection?

Answer 16

No, so a unsecured loan subject to bankruptcy

Question 17

What is ERISA protection?

Answer 17

The Employee Retirement Income Security Act of 1974 (ERISA):
- federal law that provides retirement protection for American workers
- qualified plans must follow this to ensure that fiduciaries do not misuse plan assets

Question 18

Investment options are often _____ to the 401(k) menu

(similar or different)

Answer 18

similar

Question 19

Are rollover options available in 409A Plans?

Answer 19

No, rollover options are not available, but distributions not subject to RMD at age 7

Question 20

What are some triggering events for 409A Plans?

Answer 20

fixed date, retirement, change in control, disability, death

Question 21

What are ESPPs?

Answer 21

It is a plan that gives an opportunity for employees to purchase company shares at discounted price through payroll ongoing deductions

Question 22

What is the usual discount percentage for ESPPs?

Answer 22

15% discount

Question 23

Who is allowed to get an ESPP plan?

Answer 23

It is voluntary participation, but often limited based on employment
duration

Question 24

What is the IRS cap for ESPPs per calander year?

Answer 24

$25,000

Question 25

What is a top-hat plan?

Answer 25

A top hat plan is a type of employer-sponsored plan that is unfunded. The design of the plan is to provide deferred compensation to the eligible employee group. However, participants in a top hat plan are typically high-ranking executives and directors.

One significant advantage of a top hat plan is that it does not need to undergo non-discrimination testing by regulatory bodies. Members of the plan can contribute as much as they please, a feat not typical in traditional retirement plans that face annual limits. However, contributions to top hat plans such as non-governmental 457(b) plans are immediately taxable. All distributions from top hat plans are also subject to income tax.

(non-qualified compensation plan)

Question 26

What is an excess benefit plan?

Answer 26

A plan maintained by an employer solely to provide certain employees with benefits that exceed the limits that apply to qualified retirement plans under Section 415 of the Internal Revenue Code (IRC). Only a plan maintained solely for the purpose of providing contributions and benefits in excess of those permitted under Section 415 of the IRC qualifies as an excess benefit plan. Plans designed to make up for other limits are not excess benefit plans.
Unfunded excess benefit plans are exempt from all of the requirements of Title I of the Employee Retirement Income Security Act of 1974. In addition, unlike top hat plans, there is no limit on the number or type of participants.

(non-qualified compensation plan)

Question 27

What are stock-appreciation-rights (SAR)?

Answer 27

Stock appreciation rights (SARs) are a type of employee compensation linked to the company’s stock price during a predetermined period. SARs are profitable for employees when the company’s stock price rises, which makes them similar to employee stock options (ESOs). However, employees do not have to pay the exercise price with SARs. Instead, they receive the sum of the increase in stock or cash. SARs are beneficial to employers since they do not have to dilute share price by issuing additional shares.

(non-qualified compensation plan)

Question 28

What is a phantom stock?

Answer 28

A phantom stock plan is an employee benefit plan that gives selected employees (senior management) many of the benefits of stock ownership without actually giving them any company stock. This type of plan is sometimes referred to as shadow stock.

(non-qualified compensation plan)

Question 29

What is the IRS 401 A )( 17 limit for 2023?

Answer 29

to $330,000
The annual compensation limit under sections 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) is increased from $305,000 to $330,000.

Question 30

What is the 409a rule?

Answer 30

Section 409A of the Internal Revenue Code establishes a complex regime for taxation and regulation of
nonqualified deferred compensation.

Question 31

How does 409A affect taxes?

Answer 31

The penalties for noncompliance with 409A are severe. Upon vesting, compensation deferred under a noncompliant plan or arrangement will become subject to regular federal income tax, a 20% excise tax and penalty interest accruing from the date of vesting.

Question 32

What is the $100,000 rule?

Answer 32

Maximum number of ISO a company can issue is limited to 100K that become exercisable in a calendar year based on the price of stock at the time of the award grant

Question 33

The maximum number of ISO a company can issue is limited to ________ that become exercisable in a calendar year based on the __________of stock at the time of the award ________.

Answer 33

The maximum number of ISO a company can issue is limited to 100K that become exercisable in a calendar year based on the price of the stock at the time of the award grant

Question 34

True or False
ISOs allow a tax deduction to the issuing company.

Answer 34

False

Question 35

__________ is defined as an award that vests in stages (or tranches). This is in contrast to cliff vesting, in which an award vests in its entirety on a specific date.

Answer 35

Graded vesting

Question 36

______vesting occurs when an award vests in its entirety on a specific date.

Answer 36

________ vesting, in which an award vests in its entirety on a specific date.