Module 9: Equity Compensation and Non qualified Deferred Compensation Plan
****Generally, what is the tax consequence when stock acquired using an NQSO is sold? A) No tax consequences B) Ordinary income C) Capital gain or loss D) W-2 income
When stock acquired using an NQSO is subsequently sold, there is a capital gain or loss in the amount of the sales price less the adjusted tax basis.
A rabbi trust is a revocable trust designed for current funding of a nonqualified deferred compensation plan is a vehicle used to fund benefits for executive employees who are participants in an employer's deferred compensation plan A) II only B) I only C) Both I and II D) Neither I nor II
a, The correct answer is "II only." Only statement II is correct. In a rabbi trust, assets used to fund deferred compensation are placed in an irrevocable trust, but are available to the firm's creditors.
Debbie has worked for Action Company for 15 years. On January 1, she was granted Action stock valued at $10,000 as part of a restricted stock plan. She paid nothing for the stock, and there is a substantial risk of forfeiture. On January 1, Debbie makes a Section 83(b) election. What amount, if any, will be taxed to Debbie as W-2 income? A) $0 B) $10,000 C) $7,500 D) $5,000
b, The correct answer is "$10,000." By making a Section 83(b) election, Debbie has chosen to recognize the income immediately rather than waiting until there is no longer a substantial risk of forfeiture. Therefore, $10,000 will be taxed to Debbie as W-2 income in the current year.
***** Frank exercised incentive stock options (ISOs) that were granted to him by his employer 2 years ago. He is now selling the stock 6 months after the options were exercised for a sizable profit. What is the tax treatment on this gain? A) The gain is considered ordinary income and is subject to payroll taxes. B) The gain is considered ordinary income but is not subject to payroll taxes. C) The gain is considered a long-term capital gain. D) The gain is considered a tax-free distribution of gain.
b, Because Frank did not wait 1 year after the date of exercise to sell the stock, the gain is considered ordinary income but is not subject to payroll taxes.
In order for the executive to retain the tax benefits of deferred compensation, what must be the case? The executive must not have constructive receipt of the funds. The funds must not be set aside in a specific account for the executive. The executive must have substantial risk of forfeiture. The employer must make an unsecured promise to pay the compensation. A) I, II, and III B) I, II, III, and IV C) III and IV D) I and II
b, The correct answer is "I, II, III, and IV." All of these statements must be the case in order for the executive to retain the tax benefits of deferred compensation.
A secular trust A) is subject to the claims of the employer's general creditors B) is irrevocable C) holds funds that are subject to a substantial risk of forfeiture D) provides for deferral of income taxation for employees
b, The correct answer is "is irrevocable." A secular trust is irrevocable. Funds in a secular trust are not subject to either the claims of the employer's general creditors or a substantial risk of forfeiture; therefore, the employee is taxed when the employer makes a contribution to the trust.
Which of the following statements about employee stock purchase plans is NOT correct? A) The plan must be in writing. B) No employee can acquire the right to buy more than $25,000 of stock per year, valued at the time the option is granted. C) Employees owning 2% or more of the corporation cannot participate in the ESPP. D) The option price must be at least 85% of the fair market value of the stock at the time of the grant.
c, Employees owning 5% (not 2%) or more of the corporation cannot participate in the ESPP.
Nonqualified deferred compensation plans (NQDCs) may be used to retire employees retain employees recruit employees reward employees A) I and III B) I, III, and IV C) I, II, III, and IV D) I and II
c, Nonqualified deferred compensation plans (NQDCs) may be used to recruit, retain, retire, and reward employees.
Which of the following statements regarding the tax implications of employee stock purchase plans (ESPPs) are CORRECT? Alternative minimum taxes (AMTs) apply at the time of exercise. There are no tax ramifications at the date of grant. There are no tax ramifications at the date of exercise. Upon sale of the stock, ordinary income is recognized. A) III and IV B) I, II, and III C) II, III, and IV D) I and II
c, The correct answer is "II, III, and IV." Only statement I is not correct. There are no alternative minimum tax consequences at the time of exercise. There are no tax ramifications at date of grant or date of exercise. Upon disposition of the shares, the employee will recognize ordinary income based on the lesser of the fair market value (FMV) of the stock at the grant date less the option price, or the FMV of the stock on the disposition date (or date of death, if sooner) less the option price. The balance of any gain is treated as capital gain. If the option is equal to the FMV of the stock at the date of grant, all gain upon disposition will be a capital gain as long as the shares are held by the employee for at least 2 years from grant of the option and 1 year after the exercise.
Which of the following plans features a fictional deferred compensation unit-based account? A) Nonqualified stock option B) Incentive stock option C) Employee stock purchase plan D) Phantom stock plan
d, In a phantom stock plan, a fictional deferred compensation unit-based account is created as an accounting entry.
Which of the following involves an employee receiving proceeds from a stock without actually having to purchase the stock? Phantom stock Restricted stock Stock appreciation rights (SARs) Employee stock purchase plan (ESPP) A) I, II, and III B) I, II, and IV C) I and II D) I and III
d, Stock appreciation rights are similar to phantom stock: the employee receives proceeds from the stock without having to make an outright purchase. SARs give the participant the right to the monetary equivalent of the increase in the value of shares of stock over a specified period of time.
Which of the following statements regarding stock options is/are CORRECT? Stock options are generally designed for all employees. Stock options give the employee the right to purchase a fixed number of shares of employer stock at a fixed price over a stated period of time. A) Both I and II B) Neither I nor II C) I only D) II only
d, Stock options are usually designed only for key employees.
Which of the following are requirements of incentive stock options (ISOs)? They must be part of a written plan. The exercise period cannot exceed 10 years from the date of the grant. The exercise price cannot be less than the market price of the stock at the time of the grant. The maximum value of stock (valued at the time of grant) to which ISOs may first become exercisable by the employee in any one year is $100,000. A) II, III, and IV B) I and IV C) I, II, and III D) I, II, III, and IV
d, The correct answer is "I, II, III, and IV." All of these are requirements of incentive stock options (ISOs).
All of the following are forms of equity compensation EXCEPT A) incentive stock options (ISOs) B) employee stock purchase plans (ESPPs) C) nonqualified stock options (NQSOs) D) Keogh plans
d, The correct answer is "Keogh plans." A Keogh plan is a qualified plan developed for self-employed individuals (e.g., sole proprietors and partners) and their employees.
Oscar Enterprises wants to provide a discriminatory retirement plan solely for the benefit of its executives. What type of plan should Oscar Enterprises implement? A) Nonqualified deferred compensation plan (NQDC) B) Profit-sharing plan C) Defined benefit plan D) Money purchase plan
a, A nonqualified deferred compensation plan (NQDC) would allow Oscar Enterprises to discriminate in favor of its executives, and exclude all rank-and-file employees.
Which of the following statements is CORRECT with regards to pure unfunded plans versus informally funded plans? When an employee covered by a NQDC plan must rely on the mere promise of the employer to actually pay the deferred benefit, the arrangement is called a pure unfunded plan. Informal funding is considered as unfunded because the underlying assets funding the plan are owned by the employer (rather than the executive) and are subject to the claims of the employer's general creditors. The employer owns the underlying asset used to fund the plan with a pure unfunded plan, so any earnings generated from these assets are taxed to the employer and, if the employer is a regular corporation, taxed at separate corporate income tax rates. A) I and II B) I and III C) I, II, and III D) II and III
a, The correct answer is "I and II." The employer owns the underlying asset used to fund the plan with an informally funded plan, so any earnings generated from these assets are taxed to the employer and, if the employer is a regular corporation, taxed at separate corporate income tax rates.
Which of the following statements regarding the concept of constructive receipt in a nonqualified retirement plan is/are CORRECT? Constructive receipt will be deemed not to occur if the deferred compensation is subject to substantial limitations or restrictions, also known as a substantial risk of forfeiture. Constructive receipt will be deemed to occur if the deferred compensation is credited to an executive's account, set apart for the executive, or made currently available to the executive for withdrawal. A) Neither I nor II B) Both I and II C) II only D) I only
b, Both statements I and II are correct. Constructive receipt occurs within a nonqualified plan if the executive has access to the funds or if the funds are securely set aside for the executive. The funds that are assumed to be constructively received are required to be reported as taxable income by the executive.
******On January 1, 2019, David is granted incentive stock options (ISOs) to purchase 50 shares of ABC stock at an option exercise price of $9 per share. David exercises the options and purchases 50 shares of stock on March 1, 2019. On June 1, 2020, David sells the 50 shares of stock for $600. What, if any, is the tax consequence of the sale of stock? A) Short-term capital gain of $100 B) Ordinary income of $150 C) Long-term capital gain of $150 D) Long-term capital gain of $200
b, David sold the stock within 2 years from the date of grant; therefore, any gain is considered ordinary income (not subject to payroll taxes). The taxable basis for regular tax is the option exercise price. Therefore, $600 (sales price) less $450 (option exercise price) equals ordinary income of $150.
Which of the following statements regarding nonqualified stock options (NQSOs) is/are CORRECT? NQSO grants are very inflexible. NQSOs must meet certain requirements of IRC Section 422. There are no special Internal Revenue Code requirements for NQSOs. A) II and III B) I, II, and III C) III only D) I and II
c, The correct answer is "III only." Only statement III is correct. There are no special requirements under the Internal Revenue Code for NQSOs. NQSOs are very flexible, as employers may grant an employee an NQSO on any terms, exercisable over any period of years. Incentive stock options (ISOs), not NQSOs, must meet certain requirements of IRC Section 422.
What are the income tax ramifications of exercising an incentive stock option (ISO)? There are no regular income tax consequences upon exercising an ISO. There may be an alternative minimum tax (AMT) adjustment when the ISO is exercised. A) I only B) II only C) Neither I nor II D) Both I and II
d, The correct answer is "both I and II." Both of these are the tax consequences of ISOs upon exercise.
Which of the following is an application of nonqualified deferred compensation plans? A) An employer needs to reduce an employee's compensation. B) A business wants to provide part-time employees with tax-deferred compensation. C) An employer wants to provide additional deferred compensation plan benefits to rank-and-file employees. D) An employer wants to provide a benefit to executives.
d,The correct answer is "an employer wants to provide a benefit to executives." Other applications of nonqualified deferred compensation plans are as follows. An employer wants to provide additional deferred compensation plan benefits to executives. A business wants to provide certain key employees with tax-deferred compensation. An employer needs to recruit, retain, reward, or retire an employee.
