RPA 1 Part 4

What tax advantages does an employer realize from ISO plans? (Text, p. 272)

For an employer to get a corporate income tax deduction for compensation expense, the employee must realize gross compensation income from the stock plan. In the case of an ISO, since the employee never realizes compensation income, the employer never gets a corporate tax deduction.

At the highest level of classifications, how may stock compensation plans be divided? (Text, p. 271)

Employee stock compensation plans can be divided at the highest level of classifications into two types: statutory plans and non-statutory plans.

Explain the benefit structure of an executive retirement arrangement if the plan is structured using the defined contribution approach. (Text. p. 259)

The benefit structure of a defined contribution or capital accumulation plan is relatively straightforward. The employer establishes a contribution or credit amount, accumulates the contribution or credit with actual or imputed investment income, and pays out the accumulated amount at some future time-usually upon retirement, death, disability or other termination of employment. The plan may be unfunded (as is typically the case) or funded. Some employers earmark or conditionally contribute amounts in the executive's name, but these arrangements are usually not considered to be funded as contemplated by ERISA and the tax law, and they do not involve irrevocably committed assets.

Describe the procedure involved in determining the amount of deductible contributions an individual may make to an IRA. (Text, p. 211)

Individuals may deduct the full amount ($5,500 in 2017), excluding catch-up contributions, of their regular annual contributions to IRAs if they do not actively participate in a qualified plan. However, if either the taxpayer or his or her spouse is an active participant in an employer-maintained plan for any part of a plan year ending with or within the taxable year, the maximum IRA contribution deduction is reduced (but not below zero) based on adjusted gross income (AGI), calculated without regard to any IRA contributions.

Define the term intrinsic value as it relates to stock options. (Text p. 281)

The intrinsic value of a stock option is the difference between the underlying stock's current market price and the option's strike price.

What is a solo 401(k) plan? (Text. p. 241)

A solo 40l{k) plan is simply a 40l{k) plan that is offered to a one-person firm, or a two-person firm, usually composed of the owner and her or his spouse, that must comply with all of the administrative requirements for 40I(k) plans except the filing of 5500 annual reports (provided the plan's assets are $250,000 or less).

Are there any age restrictions in connection with the eligibility to make regular annual contributions to either a traditional deductible or a nondeductible IRA? (Text, pp. 209 and 211)

An individual will cease to be eligible to make regular annual contributions to either a traditional deductible or a nondeductible IRA beginning with the taxable year in which the individual attains the age of 70 1/2. Regular IRA contributions to the IRA of the nonworking spouse can no longer be made beginning within the calendar year in which the nonworking spouse reaches the age of 70 1/2. If the employee-spouse is younger, he or she can continue to make annual IRA contributions to his or her own IRA until the year he or she reaches the age of 70 1/2

What is the penalty if a taxpayer makes an excess contribution into an IRA? (Text. p. 212)

Any excess contribution to an IRA is subject to a nondeductible 6% excise tax in addition to current income taxation. The excise tax continues to be applied each year until the excess contribution is withdrawn from the IRA.

Why would an ISO holder break ISO requirements to, in effect, change the ISO into a NQSO? (Text. P- 283)

Breaking ISO requirements may be done to avoid an AMT problem or if the stock's price is expected to fall dramatically. A planning technique that may be used in this situation is AMT neutralization. In AMT neutralization, the employee sells enough ISO shares (after exercise) in disqualifying dispositions so that his or her regular tax for the year becomes equal to his or her AMT. Then there is no AMT to pay.

What tax advantages are available to employers sponsoring employee stock purchase plans? (Text. p. 273)

Employers do not get corporate income tax deductions at grant or exercise of options under employee stock purchase plans.

What is the deadline for making IRA contributions? (Text. p. 212)

IRA contributions must be made before the due date for the individual's filing of the federal income tax return for the taxable year for which the deduction is claimed, disregarding any filing extensions.

What tax penalty is assessed if timely distributions do not occur? (Text, p. 219)

If traditional IRA assets are not distributed at least as rapidly as described above, an excise tax will be levied. This excise tax will be 50% of the excess accumulation. The 0 excess accumulation is the difference between the amount that was distributed during the year and the amount that should have been distributed under the rules described in Learning Objective 5.1.

Discuss the early withdrawal penalty in regard to withdrawals from a SIMPLE plan. (Text, p. 240)

Participants in a SIMPLE IRA who take a distribution before the age of 59 1/2 are subject to the 10% penalty tax on early withdrawals. Employees withdrawing contributions during the two-year period beginning on the date of initial participation are subject to a 25% penalty tax. A distribution from a SIMPLE account may be rolled into an IRA without penalty if the individual has participated in the SIMPLE account for two years.

What are restricted stock plans? (Text. pp. 275-276)

Restricted stock plans are arrangements by which a corporation grants stock (or stock options) to an employee (or someone rendering services to the corporation), but ownership of the stock is subject to a substantial risk of forfeiture. These plans can be part of a general compensation program or a bonus plan.

What is the tax treatment of deferred compensation if the deferral fails to conform to a stipulated exception under Section 409A of IRC? (Text. p. 264)

Section 409A of IRC generally mandates that income from deferred compensation arrangements may no longer be deferred beyond the year in which such compensation is earned, although there are certain exceptions and allowances when arrangements conform to specific requirements. Nevertheless, if a deferred compensation arrangement does not conform to a stipulated exception under Section 409A, such an arrangement would be included in income and be subject to regular taxation. Also, there would be an additional 20% tax on the amount of deferred compensation. This additional 20% tax is imposed on the service provider. (The term service provider generally refers to the employee.)

Describe the main tax advantage to employees of ISO plans. (Text. p. 271)

The main tax advantage of ISO's is that there is no regular income tax levied at the grant or at the exercise of the option by the employee. However, the bargain element upon exercise of an ISO (i.e., the difference between the fair market value of the stock at exercise and the option price) is an adjustment item for individual alternative minimum tax (AMT) purposes. Aside from this AMT issue, the employee is taxed only when he or she sells the stock purchased under the option plan, and then any gain realized is taxed as a capital gain. The capital gain would be the difference between the option price (the income tax basis of the stock) and the stock's fair market value on the date of sale. (The AMT applies to taxpayers who have certain types of income that receive favorable treatment, or who qualify for certain deductions, under federal tax law. These tax benefits can significantly reduce the regular tax of some taxpayers with higher economic incomes. The AMT sets a limit on the amount these benefits can be used to reduce total federal tax.)

What two factors must be considered in defining the compensation on which executive retirement plan benefits will be based? (Text. p. 257)

Two factors must be considered in defining the compensation on which benefits will be based: ( 1 ) The elements of pay that will be included (2) The period of time (if any) over which compensation will be averaged.

Are plan loans from Keogh plans available to all self-employed individuals? Explain. (Text. p. 233)

Because of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), loans from Keogh plans generally are permitted on the same basis as for qualified retirement plans. (However, both simplified employee pension (SEP) plans and Savings Incentive Match Plan for Employees (SIMPLE plans) individual retirement account (IRA) plans (discussed later) do not allow loans.)

Explain when distributions from a traditional IRA must commence. (Text. pp. 218-219)

Distribution from a traditional IRA must commence no later than April 1 of the calendar year after the calendar year in which the individual attains the age of 70 1/2 Although SBJPA no longer requires participants in qualified plans to begin receiving distributions after attaining the age of 70 1/2 if they are still employed, 5% owners and traditional IRA holders are exempted from these modified distribution rules. Therefore, the holder of a traditional IRA must still commence distributions following attainment of the age of 70 1/2. Distribution may be in the form of a lump sum, a life annuity or a joint life annuity or in periodic payments not to exceed the life expectancy of the individual or the joint life expectancy of the individual and a designated beneficiary. If the owner of the traditional IRA dies before the entire interest is distributed, the required distribution to the beneficiary depends upon whether distributions to the traditional IRA owner had already been required to start by the date he or she died. (a) If they have, the remaining portion of the interest is distributed at least as rapidly as under the method of distribution being used at the date of death. (b) If they have not, the entire interest of the traditional IRA owner must be distributed to a designated beneficiary, commencing in the year following the year in which the account owner's death occurred, and distribution must occur over the life of such beneficiary or over a period not extending beyond the life expectancy of such beneficiary. If a designated beneficiary is not named, the entire interest of the account must be distributed within five years of the account owner's death, regardless of who or what entity receives the distribution. (c) If the designated beneficiary is the surviving spouse of the traditional IRA owner, additional flexibility exists. • In this case, distributions do not have to begin prior to the time the traditional IRA owner would have attained the age of 70 1/2. • The spouse also may be able to roll over the death benefit to his or her traditional IRA or treat the deceased owner's traditional IRA as his or her own. Additionally, the spouse may then consider conversion of a traditional IRA to a Roth IRA.

Explain the difference between the DOL definition of a "select group of management or highly compensated employees" and the IRC definition of "highly compensated employees." (Text, pp. 248-249)

Early DOL letters were fairly liberal in interpreting the "select group" requirement. Since issuance of ERISA Proc. 76- 1 , DOL has declined to rule on whether a plan is a top-hat plan. Despite its failure to issue regulations or a definitive advisory opinion, DOL clearly has not adopted the IRC definition of highly compensated employees. Q In a statement on the subject, DOL expressed the view that the top.hat exemption would be available only for those employees who "by virtue of their position or compensation level, have the ability to affect their deferred compensation plan, taking into consideration any risks attendant thereto, and, [who] therefore, would not need the substantive rights and protection of Title I"

How is eligibility criteria usually established for an executive retirement plan? (Text. p. 256)

Eligibility for participation normally is limited to members of top management who make significant contributions to the organization's success. Eligibility should be restricted to those executives for whom the plan is really intended. Eligibility requirements that are too broad or that are established so that they automatically expand the group covered, such as with a minimum salary requirement that could be eroded by inflationary pressure, can lead to substantial cost increases for an employer.

What are employee stock purchase plans? (Text. p. 272)

Employee stock purchase plans are option arrangements under which all full-time employees meeting certain eligibility requirements are allowed to buy stock in their employer corporation, usually at a discount.

Explain the administrative issues employers avoid with a SIMPLE plan. (Text. p. 241)

Employers avoid certain administrative requirements commonly associated with a qualified plan by offering a SIMPLE plan. The following administrative requirements are avoided by offering a SIMPLE plan: (a) Employers are not required to file annual reports. (b) A SIMPLE 40l (k) plan is not subject to the nondiscrimination and top-heavy rules generally applicable to regular 40l (k) plans. This exempts them from the actual deferral percentage (ADP) test and the actual contribution percentage (ACP) test where employer matching contributions are involved. (c) Employers also are relieved of fiduciary liability under the Employee Retirement Income Security Act of 197 4 once a participant or beneficiary exercises control over account assets.

State the major employer administrative issues of SIMPLE plans. (Text. pp. 240-241)

Employers face the following administrative issues when maintaining a SIMPLE plan: (a) Employers are required to advise employees of their right to make salary reduction contributions under the plan and of the contribution alternative if elected by the employer. (b) Notification to employees must include a copy of the summary plan description prepared by the plan trustee for the employer. The summary plan description must be provided to the employees before the period in which an employee makes a plan election. (c) Employers must submit employee elective deferrals to their financial institution no later than 30 days after the last day of the month for which the contributions were made. (d) Employer matching contributions are due for deposit by the date that the employer's tax return is due, including extensions. (e) An employer makes contributions on behalf of employees to a designated trustee or issuer. (f) Plan participants must be notified that SIMPLE plan account balances may be transferred to another individual account or annuity.

Why do employers seek to have their non-qualified executive retirement arrangements fulfill one of the specified exemptions under ERISA? (Text. pp. 249-250)

Employers seek to have their non qualified executive retirement arrangements fulfill one of the specified exemptions under ERISA since an exemption from Title I requirements gives the employer considerable flexibility in plan design in areas such as participation requirements, vesting and the forfeiture of otherwise vested benefits under certain conditions. If a plan comes within the purview of Title I (for example, if it is funded or if it extends beyond a select group of executives), the following provisions of Title I apply. (a) Reporting and disclosure: Full compliance with all disclosure requirements summary plan descriptions, annual financial reporting and so forth-is required. (b) Participation requirements: The use of minimum age and service requirements must be limited to the age of 2 1 and one year of service (unless full and immediate vesting is provided). (c) Vesting: Use of vesting schedules prescribed by ERISA is required. Additionally, the vesting rules also place restrictions on mandatory distributions and cash outs and forbid non-compete clauses that call for forfeitures. (d) Joint and survivor requirements: Spousal protection, through the joint and survivor requirements, is applicable. (e) Funding: Minimum funding requirements must be met. (f) Fiduciary responsibility: The fiduciary provisions apply in full to nonexempt plans. This includes the requirement that assets of the plan be held in trust for the exclusive benefit of participants. (g) Accrual rules: Nonexempt plans must meet accrual rules identical to those applicable to qualified plans.

What are deemed IRAs? (Text, pp. 223-224)

When an employer sponsoring a qualified plan, 403(b) arrangement or governmental 457(b) plan adds an IRA feature to its plan, these add-on accounts or annuities are deemed to be either traditional or Roth IRAs. They are not subject to the normal rules applicable to the particular retirement plan to which they are attached. They are, however, subject to the reporting and other requirements generally applicable to IRAs under the Internal Revenue Code.

Describe the advantages of deferred compensation arrangements. (Text. p. 264)

While the main purpose of supplemental executive retirement plans (SERPs) is to provide the executive with an additional layer of retirement benefits over and above those provided by the employer's basic plan, deferred compensation agreements deal primarily with earnings deferral, usually to gain tax advantages, with retirement income as a secondary consideration. Postponing the receipt of current income not only reduces executives' current taxable income but puts them in receipt of the funds after retirement, when they may be in a lower tax bracket. However, any deferral of income to a future date must take into consideration the potential effects of increased interest and inflation rates as well as current tax considerations. Reasons for deferring current income from both the executive's and the employer's viewpoints are: (a) Extending the executive's income beyond normal working years into retirement (b) Spreading bonuses over a wider span of years (c) Tying the executive to the employer by stipulating conditions on the receipt of deferred amounts (d) Adding to the executives retirement income.

Explain the one exception to EEOC requirements that prohibit use of a mandatory retirement age. (Text, p. 258)

With one exception, EEOC requirements prohibit the use of a mandatory retirement age. The exception relates to individuals who have been employed for at least two years as bona fide executives or executives in "high policy-making positions" and whose nonforfeitable employer-provided retirement benefits from all sources are at least $44,000. An employer can force any such individual to retire at or after the age of 65. Employers need to consider whether they want to take advantage of this limited exception and mandate retirement at the age of 65 to the extent allowed.

Describe how EEOC regulations impact executive retirement arrangements. (Text, p. 259)

With the exception noted in Learning Objective 4.1, EEOC regulations apply to executive plans and, as a result, exert significant influence on an executive's right to remain employed after his or her normal retirement date. Therefore, individuals who are not bona fide executives or who are not in high policy-making positions must not be discriminated against on the basis of age. Even those individuals who come within the scope of the exemption must not be discriminated against on account of age if the employer does not use the exemption. Compliance with EEOC regulations means there can be no mandatory retirement prior to the age of 65 for bona fide executives and no mandatory retirement at any age for protected executives. Further, benefit accruals must continue until an executive actually retires.

Describe the design elements that (a) typically differ between executive plans and broad-based plans and (b) typically remain consistent between executive plans and broad-based plans. (Text. pp. 255-256)

(a) An executive benefit plan will have many provisions that are significantly different from the corresponding provisions in the employer's broad-based plan. These distinctive provisions usually include: • Definitions of pay and service • Benefit accrual rates • Early retirement provisions. (b) There is little need for differences in certain design elements between executive plans and broad-based plans and, in fact, consistency can be highly desirable. Some areas where consistency usually occurs include the following: • Form and manner in which benefits are distributed (i.e., joint and survivor payment options) • Other optional forms of payment • Right to make and change beneficiary designations • Facility of payment authority (if the payee is mentally or physically incapable of accepting payment) • Procedures if a beneficiary cannot be located • State law that will govern plan interpretation • Right to amend or terminate the plan. It may also be prudent to coordinate executive and base plan administration and communication, although confidentiality considerations may dictate that the plans be handled separately.

Summarize the elements of executive compensation typically (a) included and (b) excluded as compensation elements in executive retirement plans. (Text. p. 257)

(a) Base salary and short-term incentives typically are included as compensation elements in executive retirement plans. Providing benefits relating to short-term incentive pay is frequently a key plan objective. Pay may also be defined to include compensation that the executive has deferred for payment at some future time, since these amounts cannot be used to determine benefits under a broad-based plan. (b) Certain elements of compensation are typically excluded from consideration in the compensation base in an executive retirement plan. Long-term incentive plans are basically capital accumulation programs that are not considered part of regular, year-to-year compensation and thus need not be replaced when the executive is no longer working. Other items such as perquisites and other forms of imputed income are typically excluded.

An IRA rollover is a tax-free transfer of funds from a qualified plan, a 403(b) arrangement, a governmental 457(b) plan or another IRA. Describe (a) eligible rollover distributions from employer-sponsored plans and (b) the two methods of making these distributions. (Text, p. 221)

(a) Eligible rollover distributions may include any distribution except a required minimum distribution, or any distribution that is part of a series of substantially equal periodic payments over the IRA owner's life, life expectancy or a period of at least ten years. If an individual rolls over to an IRA a distribution that is not eligible to be rolled over, a 6% excise tax may be imposed on the amount rolled over until it is removed. (b) There are two methods of making rollover contributions to an IRA-a direct rollover and a regular, or indirect, rollover. In a direct rollover, the individual instructs the plan trustee or contract issuer to transfer funds directly to the IRA. In a regular rollover, the individual receives a check for the eligible rollover distribution from the plan trustee or the contract issuer (net of the required 20% federal income tax withholding) and within 60 days of receipt contributes up to the amount of the eligible rollover distribution as a rollover contribution to an IRA.

Describe (a) an excess benefit plan and (b) a top-hat plan. (Text. p. 248)

(a) Excess benefit plans provide benefits that cannot be provided through qualified plans solely because of Internal Revenue Code (IRC) Section 4 1 5 limits on benefits and contributions. If it is unfunded, an excess benefit plan is completely exempt from Title I of the ERISA. If it is funded, it is subject to the Title I reporting and disclosure, fiduciary responsibility and enforcement provisions. A supplemental plan providing benefits that a qualified plan cannot provide for reasons other than Section 415 limits-including the limit on compensation under Section 40l(a)(l7) and the dollar limit on elective deferrals-would not fall within the excess benefit plan exemption. But such a plan might be considered a top-hat plan and would, provided it is unfunded, be exempt from most ERISA requirements. (See also Learning Objective 2.l(a).) (b) Top-hat plans are plans that are "unfunded and maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees." Although they are ERISA Title I pension plans, they are not subject to the participation, vesting, funding or fiduciary responsibility provisions of Title I. However, the enforcement and reporting and disclosure requirements do apply to these plans. Under the enforcement provisions, a top-hat plan must comply with ERISA's claims review procedures and provide participants with access to federal courts to pursue a claim for benefits. The reporting and disclosure requirements that apply are simplified; the employer need only file a letter with the Department of Labor (DOL) setting forth its name, address and taxpayer identification number; the number of top-hat plans it maintains; and the number of employees in each.

A Keogh plan can be designed as either a defined benefit or defined contribution plan. (a) Describe the limits that apply to benefits available under a defined benefit Keogh plan and (b) describe the maximum annual contribution allowed under a defined contribution Keogh plan. (Text. p. 230)

(a) If a defined benefit Keogh plan is used, the same limit applies as for a defined benefit corporate pension plan; that is, the limit is the lesser of 100% of the average of the participant's highest three consecutive calendar years of earnings or $215,000 in 2017 (an indexed limit). (b) For defined contribution Keogh plans, the maximum annual contribution is the lesser of 100% of the participant's compensation or $54,000 in 2017 (an indexed limit). For the self-employed person, defined contribution plan "compensation" is the self-employed person's "earned income from self-employment" less one half of the self-employment tax (not to exceed $270,000 in 2017).

Explain (a) how much may be contributed to an IRA through a SEP and (b) how the answer changes in the case of a self-employed individual. (Text. pp. 235-236)

(a) The maximum contribution limit to a SEP is 25% of income up to $54,000 i n 2017. I f the employer contribution to the SEP i n any year i s less than the normal IRA limit applicable for that year, the employee may contribute the difference up to the allowable applicable annual limit. The employee contribution may be made either to the SEP or to one or more IRAs of the employee's choice. (b) In the case of self-employed individuals (proprietors and partners), the 25% contribution limitation will be on the basis of earned income since that term is defined in the law. This means that the contribution will be determined with reference to earned income after having subtracted the amount of the contribution and half of the self-employment tax. The result is that the 25% o contribution limit, as it is applied to these individuals, is 20% of net income before subtracting the amount of the contribution but after subtracting half of the self-employment tax.

Describe the alternatives employers have for contributions under SIMPLE plans detailing alternatives for (a) matching contributions, (b) non elective contributions and (c) employee notification requirements that accompany some of these choices. (Text. p. 239)

(a) The required employer matching contribution is either made on a dollar-for-dollar basis up to 3% of an employee's compensation for the year, or the employer could elect to match at a rate lower than 3% but not lower than 1 %. (This option to match below 3% is available to SIMPLE IRAs but not to SIMPLE 40l (k)s.) (b) Instead of making a matching contribution, an employer can opt to make a non-elective contribution of2% of compensation for each eligible employee who earned at least $5,000 during the year. (c) To apply the lower matching percentage, employers must notify employees of their intent to apply the lower match within a reasonable time before the 60-day election period in which employees determine whether they will participate in the plan. If opting to make non-elective contributions, the employer is again required to advise eligible employees of its intention within a reasonable time before the 60-day election period during which employees decide whether to participate in the plan.

Describe how benefit security is provided for the employee using (a) a "rabbi trust" or (b) corporate-owned life insurance (COLI). (Text. p. 263)

(a) Under the rabbi trust approach, the company creates an irrevocable trust for the benefit of an executive or a group of participating executives. The terms of the trust limit the use of the assets to providing benefits for the participating executives. Thus, the trust assets cannot be used by current or future management but remain subject to the claims of creditors in the event of the firm's insolvency. (b) The basic concept under the COLI approach is that the employer is the owner and beneficiary of a life insurance contract designed to accumulate sufficient cash values to pay the benefits promised the executive. The life insurance policy must be carried as a corporate asset and therefore provides only very limited benefit security for the executive since cash values and death benefits are within the employer's control.

Describe (a) the reason differences between defined benefit and defined contribution plans are less significant in executive benefit plans than with broad based plans and (b) which approach-defined benefit or defined contribution-is more prevalent. (Text, p. 254)

(a) While the relative merits of defined benefit and defined contribution plans receive considerable attention when it comes to rank-and-file employees, the differences between these two approaches are less significant in the executive arena. Potential coverage under the plan termination provisions of ERIS A often deters a company from establishing a broad-based defined benefit plan, but defined benefit executive plans are not subject to these rules. Similarly, a defined contribution executive benefit plan can be structured to avoid one of the key characteristics of a broad-based plan-the transfer of investment and inflation risks to employees. (b) Many executive benefit plans have been established on a defined benefit basis, particularly in cases where the plan builds on an underlying broad-based defined benefit plan-for example, by applying the base plan benefit formula to short term incentive compensation. The defined benefit approach works well when the plan is unfunded because it can accommodate most employer objectives and serves to coordinate benefits from all sources. It also is easy to explain and administer.

Describe the characteristics of a Roth IRA. (Text. p. 213)

A Roth IRA permits the same regular annual contribution limit as does a traditional IRA. If a taxpayer makes regular annual contributions to any other IRAs, for instance, to either a traditional deductible or a nondeductible IRA, the maximum annual contribution limit to the Roth IRA is reduced by those contributions. The rules permitting a regular annual contribution to a Roth IRA are unique to this particular retirement savings vehicle. Unlike a traditional IRA, regular annual contributions can be made to a Roth IRA at any age (even beyond the age of 70 1/2). provided the contributions do not exceed earned income for that particular year. The income phaseout on the ability to make regular annual contributions to a Roth IRA applies even if an individual is not an active participant in an employer-sponsored retirement plan. Contributions to Roth IRAs are not tax-deductible when made, but earnings accumulate tax-deferred Withdrawals of regular annual Roth contributions are tax free at any time since taxes have already been paid on these amounts. Withdrawals of earnings from Roth IRAs are tax-free (rather than tax-deferred) if the distribution is considered to be a qualified distribution.

What are the requirements of a qualified distribution for a Roth IRA? (Text, p. 213)

A qualified distribution is a distribution that is made at least five years from the first of the year in which the Roth account was established and meets at least one of the following other requirements: (a) The taxpayer has attained the age of 59 1/2. (b) The taxpayer is disabled. (c) The taxpayer has died, and payment is made to a beneficiary or to the individual's estate. (d) The distribution is made to pay firs time home-buyer expenses and does not exceed $10,000.

What are the conditions that must be met for a qualified fiduciary advisor, as defined by the Pension Protection Act of 2006 (PPA), to provide personally tailored investment advice to IRA owners? (Text, p. 216)

A qualified fiduciary advisor may provide personally tailored investment advice to IRA owners if the compensation for the advice provided does not vary with the investment option chosen or is provided through a computer model that is certified by an independent third party. The Department of Labor (DOL) believes computer models should, with few exceptions, be required to model all investment options under a plan or through an IRA. However, it is not reasonable to expect that all computer models would be capable of modeling the entire universe of investment options. Accordingly, a model would not fail to meet the conditions of the DOL regulation merely because it limits its buyer recommendations to those investment options that can be bought through the plan or IRA. In such instances, the plan participant or IRA beneficiary must be fully informed of the model's limitations in advance of the recommendations.

May a traditional IRA be converted into a Roth IRA and, if so, what taxes would such a transaction be subject to? (Text, p. 214)

A traditional IRA may be converted into a Roth IRA, subject to regular federal income taxation but not subject to the 10% penalty tax on premature distributions. (Prior to 20l0, account owners whose modified adjusted gross income exceeded $100,000 were not eligible to convert.) The Tax Increase Prevention and Reconciliation Act of 2006 removed the $100,000 modified adjusted gross income limitation to be eligible to convert a traditional IRA to a Roth IRA effective for tax years beginning after December 31, 2009. Directing

Explain why an individual might want to make IRA contributions even though they are nondeductible. (Text, p. 212)

Although contributions to an IRA will be made from after-tax income, they benefit from the compounding of tax-sheltered investment income during the time they remain in the IRA. (Note that if taxpayers make any deductible contributions, nondeductible contributions may be made but against the remaining limit.)

Employers can discriminate and make ISO's available to only some highly compensated employees. What are the requirements for a statutory stock compensation plan to qualify as an ISO plan? (Text. p. 271)

Among the number of requirements that must be met before a plan can qualify as an ISO plan are (I) the term (duration) of an option cannot exceed ten years, (2) the option price must equal or exceed the value of the stock when the option was granted, (3) an employee cannot dispose of the stock within two years from the granting of the option or within one year of the transfer of the stock to him or her (i.e., after exercise of the option), ( 4) the option must be nontransferable (except by will or inheritance at death) and (5) the maximum value of stock for which an employee can exercise ISO's for the first time in a calendar year generally cannot exceed $100,000 (valued as of the date of the grant).

What are the basic characteristics of an employee stock purchase plan?(Text, p. 272)

An employee stock purchase plan's option price cannot be less than the lower of ( 1 ) 85% o f the stock's fair market value when the option is granted or (2) 85% of the stock's fair market value when the option is exercised. Many employers use these maximum discounts as the option (strike) prices under their plans. Employees who participate agree to have an estimated amount withheld from their pay to provide the funds with which to exercise their options at the end of an option period. Employee stock purchase plans are nondiscriminatory in that they cannot favor highly paid executives.

Does an employer have wide discretion in terms of which employees it covers under a SEP plan? (Text, p. 235)

An employer does not have wide discretion in terms of which employees it covers under a SEP plan. For an IRA funded by employer contributions to be treated as a SEP, the employer must contribute to the SEP of each eligible employee. As long as the employee satisfies the eligibility criteria mentioned earlier, the employer must make contributions on the employee's behalf.

Explain the operation of a spousal IRA. (Text, p. 210)

An otherwise eligible individual also may set up and contribute to one or more IRAs for a nonworking spouse or a spouse who elects to be treated as having no compensation for the year. Under a spousal IRA plan of this type, the spouses must file a joint income tax return. Originally, if one spouse had no compensation, a married couple was restricted to a combined maximum annual IRA contribution of $2,250. The Small Business Job Protection Act of 1 996 (SBJPA) created new spousal IRA rules effective for tax years beginning after December 3 1 , 1996. Under the new rules, nonworking spouses were able to contribute up to $2,000. A combined maximum contribution of $4,000 was allowable- $2,000 for each spouse. Deductibility of this $4,000 was limited if the working spouse earned over $40,000 and participated in an employer·sponsored retirement program. The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) subsequently increased the limits applicable to IRAs and spousal IRAs. EGTRRA also permitted each spouse to make an additional catch·up contribution if each spouse meets the aged· SO threshold by the end of the tax year.

How can the application of the doctrines of constructive receipt of income and receipt of a taxable economic benefit be avoided in the design of executive retirement benefits? Explain. (Text. p. 254)

From an executive's standpoint, the employer must make sure that neither the tax doctrine of economic benefit nor the tax doctrine of constructive receipt applies. Under these two doctrines, an employee can be taxed currently on deferred benefits or compensation. The doctrine of economic benefit states that if a taxpayer is receiving a current benefit, he or she should be taxed currently on the value of that benefit; the doctrine of constructive receipt states that if a taxpayer could receive income at any time but elects to receive it later, he or she is still taxed currently because of having the nonforfeitable right to the income. Revenue Ruling 60-31 states that deferred compensation is not taxed before actual receipt whether it is forfeitable or nonforfeitable, provided: (a) The deferral is agreed to before the compensation is earned. (b) The deferral amount is not unconditionally placed in trust or in escrow for the benefit of the employee. (c) The promise to pay the deferred compensation is merely a contractual obligation not evidenced by notes or secured in any other manner. Thus, while certain assets may be earmarked and informally set aside to give some assurance that benefits will be paid, there must be no formal funding instrument, and the executive must not have current access to the benefits if current taxation is to be avoided.

What is a Section 83(b) election, and under what circumstances should a taxpayer consider it? (Text.p. 274)

IRC Section 83(b) provides that a person performing services (e.g., an employee) may elect within 30 days of a transfer to include the fair market value of the transferred property (less any amount paid for the property) in his or her gross income, even though the property is subject to a substantial risk of forfeiture or is not transferable and hence under Section 83 normally is not taxable at that point. A person receiving property for the performance of services (e.g., an executive receiving restricted employer stock) might want to make a Section 83(b) election and be taxed on the current value of the stock if the current value is relatively low, the person expects it to rise significantly in the future and he or she expects to remain with the employer at least through the forfeiture period.

Why would a solo 401 (k) likely be an inappropriate choice if a firm expanded by hiring additional employees? (Text, p. 243)

If a one-person firm was to hire additional employees, a solo 401(k) plan would likely be viewed as far too expensive because of its generous employer non-elective contributions. Because a 40 l (k) plan must be nondiscriminatory, a solo 40 l (k) plan could not be offered to the owner and his or her spouse without including the other employees.

Under what circumstances is a participant of an employee stock purchase plan eligible for favorable tax treatment? (Text. p. 272)

If plan requirements under Section 423 of the Internal Revenue Code (IRC) are met, there is no gross income for participating employees at the grant or exercise of options under employee stock purchase plans. However, to get this favorable tax treatment, an employee cannot dispose of the stock within two years from grant of the option and within one year from its exercise. If such a disqualifying disposition were to occur, the employee would be taxed as ordinary compensation income in the year of disposition, on the difference between the fair market value of the stock and the option strike price when the option is exercised. (The requirements of Section 423 pertain to the following areas: eligibility, shareholder approval, grants, exercise and holding period.)

How is the income-replacement percentage established in a defined benefit executive retirement arrangement? (Text. p. 261)

If the executive plan is strictly a restoration plan, then it by definition automatically has the same income-replacement objectives as the broad-based plan. If the executive plan is to provide benefits over and above those of the broad-based plan, the employer must decide what income-replacement percentages to use and whether to use the same percentage for executives at all pay levels. The income·replacement target for executives is often 55-60% of pay, regardless of income level. Higher percentages could provoke shareholder criticism and even raise questions as to reasonableness of compensation from the standpoint of the deductibility of plan costs.

Explain the public policy rationale for nonrefundable tax credits applicable to the first $2,000 of retirement plan contributions. (Text, p. 224)

In an effort to encourage lower- and middle-income workers to save for their retirement, a graded nonrefundable tax credit applicable to the first $2,000 of retirement contributions is available to eligible taxpayers. Retirement plan contributions eligible for the credit include contributions to traditional and Roth IRAs as well as elective contributions made to simplified employee pensions (SEPs), Savings Incentive Match Plans for Employees (SIMPLEs), 40l(k)s, 403(b)s and eligible governmental 457(b) plans.

Describe the nonrefundable tax credits that assist retirement savers directly rather than the small employers who are sponsoring some sort of retirement plan for their employees. (Text. p. 244)

In an effort to encourage lower·income and middle· income workers to save for their retirement, EGTRRA provided nonrefundable tax credits to individuals who are 18 years of age or over, unless they are full·time students or claimed as dependents on another taxpayer's tax return beginning in 2002. The credit could be claimed for tax years beginning in 2002 and was to end in 2006. PPA made these credits permanent in 2006. The credit is claimed on the taxpayer's tax return and applies to the first $2,000 in retirement plan contributions. Those retirement plan contributions eligible for the credit would include elective contributions to SEP, SIMPLE, 40l(k), 403{b), and eligible governmental 457{b) plans, as well as contributions made to traditional and Roth IRAs.

How did PPA account for the possible adverse impact of wage inflation on the nonrefundable tax credits assisting retirement savers, and what mechanism was included in the legislation to make retirement saving with the tax credit more convenient for taxpayers? (Text, p. 244)

In order to insure that wage inflation did not adversely erode the ability for individuals to make use of the nonrefundable tax credits, PPA indexed the adjusted gross income limits needed to qualify for these nonrefundable tax credits beginning in 2007. Additionally, for taxpayer convenience, PPA allowed taxpayers to direct the Internal Revenue Service, after 2006, to deposit any tax refund attributable to the saver's credit into a retirement plan or IRA.

Describe the general requirements that must be met for an employer to establish a SEP. (Text. pp. 234-235)

Internal Revenue Code (IRC) Sections 408(j) and (k), which provide the general authority for SEPs, provide for an increase in the normal IRA limit if certain requirements are met. A SEP is treated under the law as an IRA with higher limits. The employer establishing a SEP can be an incorporated entity or a self-employed individual. For the employer, a SEP is a plan that utilizes IRAs to provide retirement benefits for employees. The employer must notify the employees of the plan. The program must be defined contribution in nature; the defined benefit approach is not permitted for these plans. The SEP must be a formally adopted program with the following characteristics: (a) It must be in writing and must specify the requirements for employee participation. Further, it must specify when the employee makes contributions and how each eligible employee's contribution will be computed. (b) The employer must make contributions to the SEP for any employee who is at least 21 years of age, has worked for the employer during at least three of the last five years and has received at least $600 in 2017, indexed for cost-of-living increases, in compensation from the employer for the year. (c) Employer contributions may not discriminate in favor of any highly compensated employee (HCE). (d) Employer contributions may be discretionary from year to year. However, the plan document must specify a definite allocation formula. (e) Each employee must be fully vested in his or her account balance at all times. (f) The program may not restrict the employee's rights to withdraw funds contributed to his or her SEP at any time (i.e., the program must give unrestricted withdrawal rights to the employees). (g) The employer may not require that an employee leave some or all of the contributions in the SEP as a condition for receiving future employer contributions. (h) EGTRRA increased the percentage of compensation allowance for SEPs from 15% of compensation to 25% of compensation beginning in 2002. The Section 4 1 5 limit was changed by EGTRRA to the lesser of 100% of compensation or $40,000 for 2002. The limit on includable compensation was increased to $200,000 in 2002. Also, the amount allocated or contributed in total by the employer for the employee under a SEP and other qualified pension or profit sharing plans may not exceed the Section 415 limits. (In 2017 the Section 415 limit had increased to $54,000 and the limit on includable compensation to $270,000.) In addition, an employee may make a regular contribution to an IRA, and this is not aggregated with the SEP contributions for purposes of the 25% or Section 415 limits. (i) The top-heavy provisions of the law apply to SEP programs; however, a special provision allows employers to elect to measure aggregate employer contributions, instead of aggregate account balances, to test if the SEP has exceeded the 60% limit. (j) SEPs cannot permit employees to make loans, since the plans are IRAs.

Summarize the general design issues that an employer should consider in structuring executive benefit programs. (Text. pp. 252-254)

Many factors can influence the structure of an executive benefit program. Employer objectives, philosophy on executive compensation and benefits, and the environment will influence plan design. Additionally, the general design should consider internal equity, cost and accounting considerations, and tax considerations. (a) Internal equity: Many plans provide the same, or nearly the same, level of benefits for all executives while imposing relatively short service requirements. Concern over this internal equity issue often prompts employers to provide additional service-related benefits for long-service executives. (b) Cost and accounting considerations: Employers should consider plan costs from a cash flow perspective but also consider charges to the company's financial statements. Supplemental executive benefits generally fall within the scope of Financial Accounting Standard 87 as refined by Financial Accounting Standards 132 and 158. (These accounting standards are now found in FASB ASC Topics 960 and 962 under the new topic identification systems.). Special consideration should be given to actuarial assumptions for an executive group since items such as future salary growth, turnover and retirement ages might vary compared to patterns for rank-and-file employees. (c) Tax considerations: In an unfunded retirement plan, the employer generally is entitled to a deduction only when benefits are paid or become taxable to the executive; by contrast, the employer's contribution to a tax-qualified plan generally is deductible when made. The employer cost of providing supplemental retirement benefits could be higher than the cost of providing the benefit under a broad-based plan, because investment income under a tax-qualified plan accumulates tax-free. Retirement benefits for executives will be treated as ordinary income without special treatment for lump sums as is applicable in certain "grandfathered" situations. However, these benefits will not be subject to penalty taxes for early withdrawals or failure to meet minimum distribution requirements, as will be qualified plan payments. The issues of avoiding the tax doctrines of economic benefit or of constructive receipt are also important.

What are the basic characteristics of non-qualified stock options (NQSOs)?(Text. pp. 274-275)

NQSOs are stock options that do not meet the requirements for ISO's and so are taxed on the basis of the general principles under Sections 61 and 83. NQSOs can have terms decided upon by the parties and are not limited in the amount of stock subject to such options exercisable by an employee in any one year (as are ISO's). Hence, NQSOs can be considerably more flexible for employers and employees. NQSOs are often granted with an option price equal to 100% of the fair market value of the stock on the date of grant and for option terms of around ten years.

What are characteristics of employer-sponsored IRAs? (Text. p. 223)

One distinguishing characteristic of an employer-sponsored IRA is the fact that no requirement exists that this type of account must be made available to all employees or be nondiscriminatory in benefits. The contributions to the IRA may be made as additional compensation or by payroll deduction. Any amount contributed by an employer to an IRA is taxable to the employee as additional compensation income. The employee is then eligible for the IRA tax deduction up to the allowable annual dollar limitation for a given year, unless the "active participation in a qualified plan" rules apply, in which case the contributions may be nondeductible in whole or in part. In addition, the same reporting, disclosure and fiduciary requirements applicable to qualified plans under ERISA may apply to an employer sponsoring an IRA plan if the employer endorses the IRA. However, the participation, funding and vesting rules of ERISA do not apply. Each participant is always 100% vested in his or her IRA. Candidate Note: On July 28, 201 7 it was announced by the Trump administration that the myRA Program (described on p. 223 of the text) would be discontinued and phased out. The Treasury Department sent e-mails requesting participants to stop automatic deposits made to any myRA accounts and advised those holding these accounts to transfer balances to a Roth IRA. Furthermore, the Treasury Department indicated it did not yet have a deadline for when the accounts needed to be closed but would begin closing accounts with zero balances in September of 2017.

Discuss the restrictions on investments in an IRA. (Text, p. 215)

There are some restrictions on investments in an IRA. The assets cannot be invested in life insurance contracts except for endowment contracts with incidental life insurance features issued before 1979. Investments in collectibles such as antiques, works of art, stamps, coins and the like also are prohibited. Most IRAs are invested in assets such as bank-pooled funds, savings accounts, certificates of deposit, savings and loan association accounts, mutual fund shares, exchange-traded funds (ETFs), face-amount certificates and insured credit union accounts. A self-directed IRA arrangement also can be established. Under this approach, a corporate trustee is selected and generally charges fees for the services provided. The individual is free to make the investment decisions, within some constraints.

Summarize the ways in which stock options can be exercised. (Text. pp. 278-279)

Stock options generally can be exercised in the following ways: (a) Cash exercise: An option holder can make a cash exercise by paying the option price to the employer and having the stock transferred to him or her. (b) Stock-for-stock exercise: A plan may allow employees to pay the exercise price by delivering to the employer shares of the employer's stock that they own that are equal in value to the option price and having the option stock transferred to them. (c) Cashless exercise: This type of exercise involves working through a stockbroker who can buy the option stock from the corporation at the exercise price, sell enough stock in the open market to cover the purchase price plus his or her commissions and a small amount of margin loan interest and then deliver the remaining stock to the option holder. (d) Reload options: These are additional options that may be granted to employees when they pay the exercise price for stock with stock they own in the corporation (a stock-for-stock exercise). The reload option normally is for the same number of shares used to pay the exercise price (plus perhaps shares used for federal, state, local and Federal Insurance Contributions Act (FICA) withholding taxes) and is for the remainder of the option period of the underlying option that was exercised.

Can the assets in a Keogh plan be rolled over into other tax-deferred retirement savings vehicles? (Text. p. 233)

Tax-free rollovers from a Keogh plan to another Keogh plan, an employer-sponsored retirement plan, a 403(b) plan, a governmental 457(b) plan or an IRA are permitted.

Non-statutory employee stock compensation plans are not governed by any special provisions of IRC. Rather, these plans are interpreted under the provisions of two IRC sections related to income. Explain. (Text p. 273)

The IRC sections governing these plans that are related to income are Section 61 and Section 83. Section 6 1 simply defines gross income for federal income tax purposes. The more significant provision is Section 83, which deals with taxation of property transferred in connection with the performance of services. Section 83 in essence provides that the fair market value of property (less any amount paid for the property) transferred to a person for the performance of services shall be included in that person's gross income in the first taxable year in which the person's rights in the property become transferable or are not subject to a substantial risk of forfeiture, whichever is applicable.

Describe trustee administrative issues under a SIMPLE plan. (Text, p. 241)

The SIMPLE plan trustee bears certain administrative requirements: (a) The trustee must annually provide the employer maintaining the plan with a summary description containing certain required information. (b) Each individual participant must be supplied with an account statement, detailing account activity and an account balance, within 30 days following the end of the calendar year. (c) Trustees must also file a report with the Secretary of the Treasury. Failure to file any of these documents can result in a financial penalty until the reporting failure is remedied.

Explain the reasons that the defined contribution approach may be an attractive design for an executive benefit plan. (Text, p. 255)

The defined contribution approach can be an attractive design for an executive benefit plan for several reasons, whether or not the plan is funded. These reasons include the following: (a) Executives, accustomed to dealing with capital accumulation plans, might feel more comfortable with this approach than with a conventional income replacement approach. (b) The defined contribution approach more readily coordinates with the use of company stock and the role of stock in overall executive compensation. (c) Any imputed rates of return when benefits are unfunded can be tied to company performance measurements such as growth in profits, company stock prices, dividend growth or return on assets. (d) Several design issues, such as offsets for vested benefits from prior employment, are easier to deal with making additional contributions sufficient to attract executives in mid career, and so forth.

Why is the determination of an executive's service important under an executive retirement arrangement? (Text. p. 258)

The determination of an executive's service is important under an executive retirement arrangement because an executive's service is relevant for determining: (a) Initial eligibility to participate (b) Vesting rights (c) Benefit accruals (d) Eligibility for benefit payments.

Why must an employee be circumspect concerning the economic value of stock options? (Text. p. 282)

The economic value (fair value) of stock options granted to employees can be substantial. However, it must also be recognized that the actual value of such options may never reach the fair value at grant (from an option pricing model) and may even be zero, if the actual market price of the underlying stock fails to rise from the option price or declines.

Explain how much an employer may deduct for contributions to a SEP. (Text, p. 236)

The employer's deduction for a SEP contribution may not exceed the actual contribution made to the SEP to the extent that the contributions for each employee do not exceed the 25% and/or Section 4 1 5 limits. If the employer contributes more than the amount deductible, the employer can carry over the excess deduction to succeeding taxable years. A 10% excise tax is applied on nondeductible contributions.

What specific changes by EGTRRA made solo 401 (k) plans more attractive for sole proprietors? (Text, pp. 241-242)

The following EGTRRA changes made solo 40l(k) plans more attractive for sole proprietors: (a) Elective deferrals no longer reduced the payroll base for computing employer non-elective contributions. (b) Profit-sharing plans used as the underlying base plan in a 40l(k) plan could receive an employer non elective contribution of 25% rather than the prior allowable percentage of 1 5%. (c) Elective deferral limits were increased. (d) Employees aged 50 and over could make catch-up elective deferrals to their plans.

list the eligibility requirements for establishing a Keogh plan (also called HR-10 plan). (Text. p. 230)

The following eligibility conditions must be met in order for a Keogh plan to be established: (a) Only a sole proprietor (not a common law employee) or a partnership (not an individual partner) may establish a Keogh plan. (b) If an owner·employee wishes to establish and participate in a Keogh plan, he or she must cover all employees who are at least 21 years of age and have one year of service with the employer. A two-year waiting period can be used if the plan provides 100% vesting after the two-year period. (c) Keogh plans must meet the same nondiscrimination coverage and participation requirements as other qualified plans. (If a plan is top-heavy, the special top heavy rules explained in another section of the textbook must be met.)

The legislative intent of the Small Business Job Protection Act of 1996 when it instituted SIMPLE plans was to create a retirement savings vehicle for small employers that was not subject to the complex rules associated with qualified plans, such as the nondiscrimination requirements and top-heavy rules. List the major characteristics of SIMPLE plans. (Text, pp. 238·240)

The following list details the major characteristics of SIMPLE plans. (a) These plans may be created by employers with 100 or fewer employees who received at least $5,000 in compensation from the employer in the preceding year. (b) A SIMPLE plan may be established either as an IRA or as a 40l(k) plan. (c) Employees can make elective contributions of up to $12,500 per year in 2017 (indexed). Catch-up provisions are available for employees aged 50 and older. (d) Employers make matching contributions or nonelective contributions to a SIMPLE plan. (e) Employers have certain notification requirements to employees. (f) Nonelective contributions are subject to the $270,000 compensation cap in 2017 (indexed) prescribed by Section 40I(a)(17) of IRC, whereas matching contributions are not subject to this limitation. (g) An employer electing to create a SIMPLE plan may not maintain another qualified plan in which contributions were made or benefits accrued for service in the period beginning with the year the SIMPLE plan was created. (h) All contributions to a SIMPLE account are fully vested and nonforfeitable. (i) To participate in a SIMPLE plan, an employee must have received at least $5,000 in compensation in any two prior years from the employer, and the employee must be reasonably expected to receive $5,000 in compensation from the employer during the year. (j) There is no stipulation that a certain number of employees participate in a SIMPLE plan in order for an employer to offer such a plan. (k) Employers eligible to offer SIMPLE plans are determined on a controlled group basis, taking businesses under common control and affiliated service groups into consideration. (I) Self-employed individuals may participate in a SIMPLE plan. (m) Certain nonresident aliens and employees covered under a collective bargaining agreement may be excluded from participation.

List the six factors that the Black-Scholes option pricing model, the best known model, uses to determine the economic value of an option. (Text. p. 281)

The following six factors are used by the Black-Scholes option pricing model to determine the economic value of an option: ( 1 ) Option exercise price (strike price) (2) Current market price of the underlying stock (3) Risk-free interest rate during the expected term of the option (4) Expected dividend yield on the stock (5) Expected life of the option. This is the time period for which the employee is actually expected to hold the option before exercising it. It may be shorter than the maximum option period in the plan. (6) Expected volatility of the underlying stock's market price. This normally is the most important factor in the model, since the greater the volatility, the greater the option value will be.

Describe the tax treatment of restricted stock plans for employees and the employer. (Text, pp. 276-2771

The general principles of Section 83 apply. That is, an employee receives ordinary compensation income in the year the employee's rights to the stock are first not subject to the substantial risk of forfeiture or are transferable. The gross income is measured by the fair market value of the stock at that time, less any cost to the employee. However, depending on the circumstances, a Section 83(b) election (described earlier) may be considered. A person receiving restricted stock must make a planning decision regarding this election. Again, the employer gets a corporate income tax deduction when the employee receives gross compensation income.

Describe the eligibility requirements typically used under an executive retirement plan. (Text. pp. 256·257)

The most frequently used criterion to establish eligibility for participation is position. For the reason noted in Learning Objective 3.2, a minimum salary requirement generally is not desirable unless it is tied to some sort of price or wage index. Some organizations determine eligibility by whether the executive is eligible for the company's incentive compensation program. No constraints are imposed by IRC or ERISA on the selection of eligibility criteria; however, if the group covered is so large that it extends beyond "a select group of management or highly compensated employees:· the plan could become a retirement plan as defined under Title I of ERISA and thus become subject to all of its requirements.

Summarize the primary objectives in establishing executive retirement arrangements. (Text. pp. 250·252)

The objectives most frequently set forth for implementing a supplemental executive retirement plan include the following. (a) Restoring base plan benefits: Most major employers have adopted excess benefit plans to replace retirement benefits that would have been payable under broad based qualified plans were it not for the Section 415 limits. Many employers also have acted to restore qualified plan benefits lost by reason of other tax law provisions, such as the 401(a)(17) limit on pay that can be taken into account for qualified plan contributions and benefits and the elective deferral limit for 401 (k) plans. Plans structured to restore benefits lost because of these latter two limits must be structured as top-hat plans rather than as excess benefit plans. (b) Providing more benefits: Often the objective of an executive benefit program is to provide a higher level of benefits than that generated by the company's broad based plans. (c) Mid-career recruiting: An executive changing jobs in mid- to late-career could suffer a significant loss in expected pension benefits because the pension from his or her former employer, although vested, will be frozen at the executive's pay level at the time of change. Even though pension benefits from the new employer will accrue at future pay levels, the total benefit from the two sources could fall substantially short of the benefit had the executive been employed by only one employer for a full career. This issue may be addressed by establishing a supplemental retirement plan providing additional benefits to an executive hired in mid career. The program may be structured to recognize service with the former employer as though it were service with the current employer or to grant relatively generous accruals for the first few years of new employment. (d) Recognizing incentive pay: Many broad-based plans provide benefits related to base pay only. Many employers believe that at least some executive incentive pay should be treated as an element of pay for benefit purposes because an executive's standard of living is based on total compensation and in part because they believe an executive whose pay is at risk should reap commensurate rewards. (e) Executive transfers: One solution if an organization's benefit programs are not uniform from one operation or location to another is to provide a supplemental umbrella plan that makes up any difference between the specified umbrella level of benefits and the benefits actually provided at the locations where the executive has been employed. (f) Other objectives: There may be many other reasons for executive benefit programs, including: • Recognizing deferred compensation: Because deferred compensation cannot be considered as pay for determining qualified plan benefits or contributions, employers often establish supplemental arrangements to provide benefits related to deferred amounts. • Golden handcuffs: Unfunded executive retirement plans need not comply with the vesting rules that apply to broad-based plans. A supplemental plan with rigorous vesting standards can help retain key executives, since a terminating executive will forfeit accrued benefits unless termination occurs under circumstances where the employer is willing to provide these benefits. • Non compete provisions: Broad-based plan benefits cannot be forfeited once they are vested; such is not the case for unfunded supplemental executive benefits, which can be forfeited even after they are in payment status. Making benefits subject to forfeiture if an executive goes to work for a competitor after retirement could be a way of providing some protection in this event. • Golden handshakes: It may be desirable to encourage certain executives to retire before their normal retirement ages. If benefits under broad-based plans are insufficient to meet retirement income needs, supplemental benefits can be used to provide early retirement incentives. • Uniform treatment: Organizations often enter into different deferred compensation and supplemental benefit arrangements with individual executives as a result of negotiated employment agreements or corporate acquisitions. Supplemental executive benefit plans can standardize these arrangements and establish a uniform policy, avoiding the need for special contracts and disclosure.

What are the deduction limits for the owner under a Keogh plan? (Text. p. 231 )

The owner's deduction for contributions for himself or herself is based on the owner's earned income from self-employment, which takes into account the deduction for one-half the self-employment tax and the deduction for contributions to the plan on the owner's own behalf. In a profit-sharing plan, for example, the maximum deductible contribution for the self-employed individual is 20% of earned income, less one-half the self-employment tax, before subtracting the amount of the contribution.

Discuss the reasons the valuation of employee stock options is a complex task. (Text. p. 280)

The valuation of employee stock options is made complex first by the fact that they are different in many ways from publicly traded stock and other options. In essence, however, employee stock options are really call options for the employees on employer stock. The valuation of employee stock options is also done for a variety of reasons. To the extent employers "expense" options when they vest, obviously they must be valued. Also, employees want to know what they are really worth, since options have become an important part of many compensation arrangements. They also need to be valued for purposes of an employee's asset allocation planning. In some cases, employees may give up cash compensation in exchange for stock options, so they want to have an idea of what the options are worth to evaluate the exchange. Finally, employee stock options may need to be valued for estate planning.

List conditions under which IRA premature distributions (distributions taken prior to the age of 59 1/2) are exempt from the 10% penalty tax. (Text, p. 220)

There are a number of conditions under which the 10% penalty tax for premature distributions does not apply. First of all, the penalty does not apply to distributions made on account of the IRA owner's death or disability. Subject to certain payment patterns, an exception also exists for substantially equal periodic payments made at least annually over the life or life expectancy period of the individual or the joint lives or life expectancy of the individual and a beneficiary. Also, the 10% penalty tax does not apply if a withdrawal is made because of an Internal Revenue Service levy on the account to collect taxes and if a withdrawal is made to an alternate payee pursuant to a qualified domestic relations order (QDRO). In addition, subject to certain limits and conditions, the penalty does not apply to distributions taken to pay medical expenses, health insurance premiums after separation of employment, qualifying education expenses and first-time home buyer expenses (limited to $10,000).

Discuss the vesting requirements typically associated with stock option plans as well as the rules regarding transfer of option ownership. (Text, p. 277)

There generally are vesting requirements in stock option plans with periods for vesting varying but often ranging from two to four years. As for transfer-ability of ISO's, one of the requirements to be an ISO is that the option by its terms must not be transferable (other than by will or intestate distribution) and must be exercisable during the employee's lifetime only by him or her. As for NQSOs, traditionally corporations in practice have not allowed their NQSOs to be transferable. Recently, some corporations have amended their stock option plans to allow NQSOs to be transferred (given) to members of the employee's family, trusts for such members or possibly family·limited partnerships with such members as partners, with the consent of the corporation. (See page 278 of the text for some innovative stock option programs that are allowing greater transfer-ability.)

Describe the tax treatment of NQSOs plans for employees and the employer. (Text. p. 275)

There normally is no taxable event (gross income) at grant because the tax regulations view their value then as not being readily ascertainable. On the other hand, upon exercise of an option (and transfer of the stock to the employee), the employee will receive ordinary compensation income for regular federal income tax purposes equal to the difference between the fair market value of the stock at exercise and the option price {the bargain element). The employee's income tax basis in the stock is its fair market value at exercise. This is because the employee paid the option price to the employer (a cost basis) and included the remainder of the stock's value (bargain element) in his or her gross income as compensation {basis under the tax benefit principle). Thus, an immediate sale of the stock by the employee (there are no two-year and one-year holding periods for NQSOs) will produce zero capital gain or loss since the amount realized would equal the adjusted basis for the stock. The employer gets a corporate income tax deduction for the amount of compensation income the employee realizes at exercise of the option.

What rules issued by the Internal Revenue Service must be followed when deferred compensation agreements are drafted to avoid constructive receipt of the deferred funds by the executives? (Text, p. 264)

To avoid the possibility of the executives being judged to be in constructive receipt of the deferred funds, three rules contained in Revenue Ruling 60-31 must be followed in drawing up a deferred compensation agreement. They are that the deferral must be: (1) Irrevocable (2) Agreed to before the compensation is earned (3) For a specified length of time. Also, the agreement must serve a business purpose.

On what type of income may IRA contributions be based? Explain. (Text. pp. 208-209)

To be eligible to establish an IRA, an individual must have earned income from personal services- Investment income does not qualify for such a plan. If an individual and spouse both have compensation or self-employment income during a taxable year, each spouse may establish an individual retirement savings plan. Community property laws do not apply to such plans. If an individual is married and otherwise eligible to make IRA contributions and has a nonworking spouse, two IRAs may be established, but they are subject to certain limitations.

Provide two examples of prohibited transactions under the Employee Retirement Income Security Act (ERISA) for individual retirement savings plans. (Text. p. 217)

Two examples of prohibited transactions are (1) an individual who owns an individual retirement annuity and borrows any money under or by use of that annuity contract and (2) an individual who holds an IRA and uses all or any portion of the account as security for a loan. In the first example, the annuity loses its tax· exempt status, and its fair market value will have to be included in the individual's gross income, possibly subject to premature distribution excise taxes. Similarly, in the second example, the portion used to secure the loan will be treated and taxed as a distribution.

What incentives for small employers to offer plans does EGTRRA provide in addition to liberalized plan provisions? (Text. p. 243)

Under EGTRRA provisions, made permanent by the Pension Protection Act of 2006 (PPA), small employers with no more than 100 employees receive a tax credit for costs associated with establishing new retirement plans. The credit equals 50% of the costs in connection with creation or maintenance of a new plan. The credit is limited to $500 annually and may be claimed for qualified plan costs incurred in each of the three years beginning with the tax year in which the plan first becomes effective. Additionally, to encourage the introduction of small employer plans, EGTRRA enacted provisions that exempt a small employer from paying a user fee. The law exempts the small employer from fees for any determination letter request to the Internal Revenue Service, with respect to the qualified status of a retirement plan that the employer maintains if the request is made within certain time frames.

An individual may establish an individual retirement savings plan by making contributions to an IRA or an individual retirement annuity. Describe the annuity type of plan. (Text. pp. 215·216)

Under this type of plan, the individual's contribution is invested through the purchase of a flexible premium annuity IRA from a legally licensed life insurance company. The annuity contract must involve flexible premiums and may be participating or nonparticipating. Also, the annuity may be fixed or variable. Key requirements of a flexible premium annuity IRA include nontransferability, nonforfeitability and restrictions on the treatment of dividends.

How can investments known as leaps assist in the valuation of employee stock options? (Text p. 280)

Unlike most traded options that have relatively short duration's, such as a few months, leaps are longer term, publicly traded options. Consequently, just to get an idea of how the market values longer term options relative to the prices of the underlying stocks, it may be instructive to note the market premiums (prices) for leaps.

How is the vesting provision in an executive retirement arrangement established? (Text, p. 262)

Vesting in executive benefit plans often parallels the vesting provisions of the underlying broad·based plan. However, vesting provisions may be designed to be more liberal than those of the broad-based plan. This often occurs if the purpose of the executive plan is to facilitate mid-career recruiting or to encourage executives to retire early. On the other hand, if the intent of the executive plan is to create golden handcuffs, vesting requirements may be more stringent and may occur only when an executive qualifies for retirement.