Transcript Chartered Retirement Planning CounselorSM Professional

CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Retirement Planning & Employee Benefits
Module 8
Deferred Compensation &
Stock Plans
©2013, College for Financial Planning, all rights reserved.
Learning Objectives
8–1 Identify characteristics of a nonqualified deferred
compensation plan.
8–2 Identify concepts relating to taxation of a nonqualified
deferred compensation plan.
8–3 Identify characteristics of a given form of informal
funding for a private, unfunded nonqualified deferred
compensation plan.
8–4 Identify characteristics of a restricted stock plan and
analyze a Section 83(b) election.
8–5 Identify characteristics of incentive stock options
(ISOs) and employee stock purchase plans (ESPPs).
8–6 Identify characteristics of nonqualified stock options
(NSOs) and other types if incentive stock plans.
8-2
Questions to Get Us Warmed Up
8-3
Learning Objectives
8–1 Identify characteristics of a nonqualified deferred
compensation plan.
8–2 Identify concepts relating to taxation of a nonqualified
deferred compensation plan.
8–3 Identify characteristics of a given form of informal
funding for a private, unfunded nonqualified deferred
compensation plan.
8–4 Identify characteristics of a restricted stock plan and
analyze a Section 83(b) election.
8–5 Identify characteristics of incentive stock options
(ISOs) and employee stock purchase plans (ESPPs).
8–6 Identify characteristics of nonqualified stock options
(NSOs) and other types if incentive stock plans.
8-4
Definition of Nonqualified Deferred Compensation
“A nonqualified deferred compensation plan means
any plan that provides for the deferral of
compensation.”
 American Jobs Creation Act of 2004
8-5
Nonqualified Deferred Compensation Overview
409A—Increased restrictions on deferred
compensation
• Nonqualified plans are ideal for business owners
and key employees who want to provide
benefits for themselves in excess of qualified
plan limitations.
• The historically low personal income tax
brackets make nonqualified deferred
compensation less attractive than previously.
• The prospect of rising taxes in the future also
makes nonqualified deferred compensation less
attractive.
8-6
Nonqualified vs. Qualified Plans
Characteristic
Qualified Plan
Nonqualified Plan
Internal Revenue Code Requirements
Discrimination
Plan may not discriminate
Plan may discriminate
ERISA Requirements
All plans must satisfy ERISA and
IRC requirements
Certain plans are partially exempt
from ERISA
Employer deduction
Available in year of plan
contribution
Available in year of employee
taxation
Employee deferral
Tax deferred until plan
distribution; rollovers allowed
Tax deferred only if unfunded or
funds are at risk; no rollovers
Fund earnings
Earnings accrue tax deferred
until distribution
Earnings usually are currently
taxable to employer
Distributions
Taxed at ordinary rates;
averaging may be available on
lump sums
Taxed at ordinary rates; averaging
not available on lump sums
Tax Treatment
8-7
Types of Nonqualified Deferred Compensation
• Pure deferred compensation (employee funded)
• Supplemental plans (employer funded)
o Excess benefit plan
o Supplemental Executive Retirement Plan
(SERP)
o Death Benefit Only plan (DBO)—
provides a survivor benefit
8-8
Excess Benefit Plans
• An excess benefit plan is linked indirectly to the
•
•
qualified plan or plans in place and provides for
benefits in excess of the amount to which the
employee would otherwise be entitled under
the qualified plan.
The payment is typically made when the
employee retires and is usually paid out the
same way that benefits are paid under a
qualified retirement plan.
The plan may be funded,
informally funded, or
unfunded.
8-9
Supplemental Executive Retirement Plans (SERPs)
•
•
•
A SERP (or top hat plan) is an unfunded plan providing
benefits for select employees (generally only high-level
executives) in excess of those provided by the employer’s
qualified retirement plan.
o Benefits are usually based on elements of compensation
not otherwise provided under the qualified plan (such as
a benefit formula with a higher multiple of earnings or
ignoring altogether Social Security integration levels).
SERPs can be used for a broader range of purposes than
excess benefit plans.
Unfunded SERPs are exempt from all
but the reporting and disclosure
requirements of ERISA.
8-10
Learning Objectives
8–1 Identify characteristics of a nonqualified deferred
compensation plan.
8–2 Identify concepts relating to taxation of a nonqualified
deferred compensation plan.
8–3 Identify characteristics of a given form of informal
funding for a private, unfunded nonqualified deferred
compensation plan.
8–4 Identify characteristics of a restricted stock plan and
analyze a Section 83(b) election.
8–5 Identify characteristics of incentive stock options
(ISOs) and employee stock purchase plans (ESPPs).
8–6 Identify characteristics of nonqualified stock options
(NSOs) and other types if incentive stock plans.
8-11
Nonqualified Deferred Compensation Tax Implications
To employer
• Deduction when taxed
to employee
• Earnings taxed to
employer
To employee
• Taxed when benefit
constructively received
• Subject to FICA taxes
when constructively
received
8-12
ERISA Requirements for Nonqualified Deferred Compensation Plans
Reporting
and
Disclosure
Participation,
Vesting, and
Funding
Fiduciary
Responsibility
Unfunded Plan
or Trust
Must comply
Exempt if top-hat
plan; must comply
if plan includes
rank and file
Exempt if top-hat
plan; must comply
if plan includes
rank and file
Exempt if tophat plan; must
comply if it
includes rank
and file
Funded Plan or
Trust
Must comply
Must comply
Must comply
Must comply
Government,
Church,
Unfunded
Excess Benefit
Plans
Exempt
Exempt
Exempt
Exempt
ERISA
Plan
Termination
Insurance
8-13
Nonqualified Deferred Comp Funding
Unfunded
• Promise to pay
• Agreement executed prior to service performance
• Available to company creditors
Funded
• Not available to employer’s creditors
• Currently taxable to employee unless substantial risk of forfeiture
Informally Funded
• Employer “informally” dedicates
assets to through accounting
device or segregating assets
to a trust
• Rabbi Trust an example
8-14
Rabbi Trust
• A rabbi trust is an employer•
•
sponsored irrevocable grantor
trust
Trust has two beneficiaries:
o the employee and
o creditors of the company
Trust earnings are
currently taxable to
the employer
8-15
Secular Trust
• Irrevocable fully funded trust established for an
•
•
employee
Employee is vested in contributions,
so current taxation to employee
results
Assets are not subject to
the claims of an
employer’s creditors
8-16
Requirements for Deferral of Taxation
IRS Regulations stipulate three principles that
must be followed for deferred compensation:
1. The agreement to defer compensation must be
made before the dollars are earned
2. The agreement must represent only an unsecured
promise
3. The agreement cannot be funded (i.e., any funds
used to provide the benefit must be held by the
employer as a general asset
available to creditors)
8-17
Substantial Risk of Forfeiture
• Employee’s right to payments must be
•
•
contingent upon future performance of
substantial services (death or disability are not
considered substantial services)
Plan must provide for loss of rights to payments
if substantial services are not performed OR if
employment terminates for reasons other than
death or disability
Generally only
relevant in
funded plans
8-18
Constructive Receipt
• The constructive receipt issue isn’t whether the
•
taxpayer has actually received the income, but
whether he/she has access to it
To avoid constructive receipt, agreements
usually contain specific provisions
establishing substantial risk of forfeiture
(funded plans), or
availability of funds
to company’s
general creditors
(unfunded plans)
8-19
Economic Benefit
• Economic benefit relates to the receipt of
•
•
non-cash property that can be valued in cash
When the employee’s benefit is treated as the
equivalent to the receipt of cash, current
income taxation will result
In unfunded and unsecured plan,
mere promise to pay
does not confer
economic benefit
8-20
Learning Objectives
8–1 Identify characteristics of a nonqualified deferred
compensation plan.
8–2 Identify concepts relating to taxation of a nonqualified
deferred compensation plan.
8–3 Identify characteristics of a given form of informal
funding for a private, unfunded nonqualified deferred
compensation plan.
8–4 Identify characteristics of a restricted stock plan and
analyze a Section 83(b) election.
8–5 Identify characteristics of incentive stock options
(ISOs) and employee stock purchase plans (ESPPs).
8–6 Identify characteristics of nonqualified stock options
(NSOs) and other types if incentive stock plans.
8-21
“Stock” Plans
•
•
•
•
•
•
•
•
Restricted stock
ISOs
ESPPs
NSOs
SARs
Phantom stock
Performance unit or
share plans
Junior stock
8-22
Restricted Stock Plans
• Shares of stock are granted to the employee at
•
•
•
no cost or at a bargain price, subject to
restrictions
There is no taxable transaction when shares are
granted (unless 83(b) election)
They are taxed as compensation
when constructively received
Capital gain holding period
begins when restrictions are
lifted (or when taxed under
83(b) election)
8-23
Employee Stock Options: The Option Agreement
The option agreement specifies:
•
the number of shares of stock that can be
purchased,
•
•
•
the price of the stock,
the date when the options will expire, and
terms under which the options can be
used
The terms under which the options
can be exercised include:
•
the dates when the options can be
exercised,
•
specific requirements that must be met
before the options can be exercised, and
•
whether the option holder must be
employed by the company when the
options are exercised
8-24
Learning Objectives
8–1 Identify characteristics of a nonqualified deferred
compensation plan.
8–2 Identify concepts relating to taxation of a nonqualified
deferred compensation plan.
8–3 Identify characteristics of a given form of informal
funding for a private, unfunded nonqualified deferred
compensation plan.
8–4 Identify characteristics of a restricted stock plan and
analyze a Section 83(b) election.
8–5 Identify characteristics of incentive stock options
(ISOs) and employee stock purchase plans (ESPPs).
8–6 Identify characteristics of nonqualified stock options
(NSOs) and other types if incentive stock plans.
8-25
Incentive Stock Options (ISO)
Requirements
• Can only be offered to employees
•
Must be issued under a written plan approved by
the stockholders of the corporation
•
The option term and exercise period cannot exceed
10 years
•
The option price must equal or exceed the FMV of
the stock at the time of the grant1
•
The options must expire no later than three months
after employment is terminated
•
The option can only be exercised by the option
holder and cannot be transferred, except at the
death of the option holder
•
No more than $100,000 can be exercised in one
year
If the employee owns more than 10% of the voting stock of the company,
the option price must be at least 110% of the FMV.
1
8-26
Tax Treatment of Incentive Stock Options
• No income tax is owed when the ISOs:
•
•
•
o are granted and
o are exercised
The difference between 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 owed when the stock purchased
with the ISOs is sold
How the gain will be taxed
depends on whether the
disposition is a “qualifying
disposition” or a
“disqualifying
disposition”
8-27
Understanding Stock Option Terms
Price
Disposition price
$25
FMV at exercise
Exercise price
$15
$10
Grant date
Exercise date
Disposition date
Time
Holding Periods and Taxation of ISOs
Price
Disposition price
$25
FMV at exercise
Exercise price
$15
1 year
from
exercise
2 years from grant
$10
Grant date
Exercise date
Disposition date
Time
8-29
Taxation of ISO Disqualifying Disposition
The tax treatment of a disqualifying disposition is the same as for an NQSO (except for FICA
and withholding rules). Disqualifying dispositions generally do not have AMT ramifications.
Price
Disposition price
$25
FMV at exercise
Exercise price
$10
Grant date
$10
$15
$5
Holding period
requirement
not met
Exercise date
Held less
than 1 year
– entire gain
taxed as
ordinary
income
Disposition date
Time
8-30
Employee Stock Purchase Plans (ESPPs)
• $25,000 annual maximum
• Shares can be sold at up to a 15% discount
• Same holding period requirement as ISOs for
capital gains treatment
8-31
Nonqualified Stock Options (NQSOs)
• Options can be given to both employees and
•
•
•
•
non-employees
Exercise price must equal or exceed FMV of
stock at time of grant
The company can set the requirements for
exercising the options
The company can determine the conditions
under which the options are forfeited
No holding period rules apply
8-32
Tax Treatment of NQSOs
•
•
•
•
The options are not taxed
when granted unless they
have an ascertainable value
Taxed as compensation (W-2
income) upon exercise of the
option (bargain element)
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 a long-or short-term
capital gain or loss
8-33
Taxation of Nonqualified Stock Options
Price
Disposition price
$25
FMV at exercise
Exercise price
$10
Grant date
$10
$15
Capital gains
$5
Compensation
Exercise date
Disposition date
Time
8-34
Stock Option Comparison (1)
The plan must:
ISO
NQSO
Be a written document
Yes
Yes
Declare the number of shares subject to grant
Yes
No
Declare employees or classes eligible
Yes
No
Obtain shareholder approval 12 months before
or after adoption
Yes
No
8-35
Stock Option Comparison (2)
The options must:
ISO
NQSO
Be granted within 10 years of approval or
adoption of plan
Yes
No
Be exercisable no later than 10 years after the
grant (5 years for >10% owner)
Yes
No
Be exercisable at no less than FMV on date of
grant (110% for >10% owner)
Yes
No
Be nontransferable
Yes
No
Be limited to no more than $100,000 a year in
FMV of shares per year
Yes
No
8-36
Stock Option Comparison (3)
Recipient must meet holding period of:
ISO
NQSO
From date of grant
2 years
None
From date of exercise
1 year
None
Be an employee on date of grant
Yes
No
Exercise options within timeframe
3 months
following
termination
No
8-37
Employee Stock Options
Gives the employee the right to purchase
shares of stock in the employer’s company for
a set price during a specified time period
• Employee stock options are not free company stock
• The recipient isn’t required to use them
• They have no risk in and of themselves
• They have value only when used
8-38
Other Stock Plans
• Stock appreciation rights
•
•
•
(SARS)
Phantom stock plans
(employee cannot choose
exercise date)
Performance unit or share
plans
Junior stock plans
8-39
Parachute Plans
•
•
Golden Parachutes
(typically for executives)
o Payment has an aggregate present
value of not more than three times
the individual’s base amount (safe harbor)
o Excess payments are not deductible
to employer and subject to 20% excise tax
Tin parachutes
(typically for middle-management)
o Similar to golden parachutes, but on a
much smaller scale
8-40
Multiple Choice Question 1
Rex works for Titan Industries, which is currently trading at $12
per share. The company awards him incentive stock options
(ISOs) for 2,000 shares with an exercise price of $12. Rex
exercises (but does not sell) the options three years later when
the stock is trading at $45 per share.
Which of the following statements is correct?
a. Upon exercise, Rex will owe taxes (W-2 income) on $24,000
(2,000 shares x $12 exercise price).
b. Upon exercise, Rex will owe taxes (W-2 income) on $66,000
($33 difference on 2,000 shares—difference between the
$45 current price and $12 grant price).
c. Upon exercise, Rex will be subject to AMT taxes of $45 per
share.
d. Upon exercise, Rex will not owe any regular income taxes.
8-41
Multiple Choice Question 2
Rex was also granted some nonqualified stock options (NSOs),
with an exercise price of $15 per share (issued when the
company stock was trading at $15 per share). His grant was for
4,000 shares, which he exercises (but does not sell) two years
later when the stock is trading at $50 per share.
Which of the following statements is correct?
a. Upon exercise, Rex will owe taxes (W-2 income and payroll
taxes) on $200,000 (4,000 shares x $50 per share).
b. Upon exercise, Rex will owe taxes (W-2 income and payroll
taxes) on $140,000 ($35 difference on 4,000 shares –
difference between the $50 current price and the $15 grant
price).
c. Upon exercise, Rex will be subject to AMT taxes on
$140,000.
d. Upon exercise, Rex will not owe any regular income taxes.
8-42
Multiple Choice Data
Jim Dandy, the CEO of Dandy Industries, was awarded the following stock options
from his company:
Stock Option
Grant Date
Type
Grant Price
# of shares
AA
2006, Mar 1
NSO
$15
5,000
BB
2007, Feb 1
ISO
$20
1,000
CC
2008, Oct 1
ISO
$30
1,000
DD
2009, Aug 1
NSO
$35
,5000
During the current year, 2013, Jim has the following transactions with the stock
options:
Number of
Shares
Stock Option Date
Action
AA
2013, Jan 1
During the current year, Jim
BB
2013, Feb 1
BB
2013, Feb 1
CC
2013, Mar 1
DD
2013, Apr 1
DD
2013, Oct 1
Exercise
has the following
Exercise
Sold
Exercise
Exercise
Sold
Mkt Price on Action
Date
3,000
$77
transactions with the stock options:
1,000
$78
1,000
$78
1,000
$80
2,000
$82
2,000
$85
8-43
Multiple Choice Question 3
Which of the following is correct for options AA
for 2013?
a. Jim has W-2 income, subject to payroll
taxes, of $186,000.
b. Jim has a short-term capital gain of
$186,000.
c. Jim has a long-term capital gain of
$186,000.
d. Jim has no tax liability since the shares were
exercised but not sold.
8-44
Multiple Choice Question 4
Which of the following is correct for options BB
for 2013?
a. Jim has a short-term capital gain of $58,000.
b. Jim has a long-term capital gain of $58,000.
c. Jim’s sale is a disqualifying disposition, and
he has W-2 income of $58,000.
d. Jim has AMT income in the amount of
$58,000.
8-45
Multiple Choice Question 5
Which of the following is correct for options CC
for 2013?
a. Jim has no tax liability since the shares were
exercised but not sold.
b. Jim has a $50,000 long-term capital gain
since the shares have been held more than
two years since the grant date.
c. Jim’s exercise is a disqualifying disposition,
and he has W-2 income of $50,000.
d. Jim’s exercise will result in AMT income of
$50,000.
8-46
Multiple Choice Question 6
Which of the following is correct for options DD
for 2013?
a. Upon exercise, Jim will have W-2 income of
$94,000.
b. Upon exercise, Jim will have W-2 income,
with payroll taxes of $94,000.
c. Upon exercise, Jim will not owe any taxes
since the shares have not been sold yet.
d. Upon exercise, Jim will have AMT income of
$94,000, but no regular income taxation.
8-47
Multiple Choice Question 7
Which of the following is correct for options DD
for 2013?
a. Upon sale of the stock, Jim will have W-2
income, with payroll taxes, of $100,000.
b. Upon sale of the stock, Jim will have W-2
income of $6,000.
c. Upon sale of the stock, Jim will have a shortterm capital gain of $6,000.
d. Upon sale of the stock, Jim will have AMT
income of $100,000.
8-48
Multiple Choice Question 8
Which of the following statements is true?
I. Upon exercise, W-2 income is reported, and
payroll taxes due, for NSOs.
II. Upon exercise, W-2 income is reported for ISOs.
III. Upon exercise, AMT taxable income will be
created if the ISO is not sold by the end of the
year.
IV. If an ISO is sold in the same year as exercised,
there will not be any AMT income reported.
a. I and III only
b. II and III only
c. I, III, and IV only
d. II, III, and IV only
8-49
Multiple Choice Question 9
Which of the following does not describe an
instance when an employer is generally allowed
to take a deduction for its contribution to a
nonqualified deferred compensation
arrangement?
a. When the employee becomes vested.
b. When the contribution is actually made to
the plan.
c. When the employee has constructive receipt.
8-50
Multiple Choice Question 10
Manning Manufacturing wants to implement a
nonqualified deferred compensation plan that
will enable the company to set aside the same
10% they are contributing into the profit
sharing plan for amounts executives earn above
the $250,000 Section 415 limit.
You would recommend a(n)
a. SERP.
b. death benefit only plan.
c. rabbi trust.
d. excess benefit plan.
8-51
CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Retirement Planning & Employee Benefits
Module 8
End of Slides
©2013, College for Financial Planning, all rights reserved.