Retirement Planning and Employee Benefits - Nonqualified Plans

What is federal estate tax treatment?

- The amount of death benefit payable to a beneficiary under a nonqualified DC plan is often included in the deceased estate, at its present value.

Rudolph is participating in the incentive stock option plan offered by his company. Generally, when will the benefits of this plan be taxed?

- On the date the stock is sold or exchanged. Rudolph is subject to federal income tax at the time of disposition of the stock. The income tax will not be applicable at the time the option is granted or at the time Rudolph exercises the option.

What is the first thing most executives covered under a plan want to know?

- What benefits are provided? Executives covered under the plan first want to know what benefits the plan provides, rather than methods of financing those benefits, such as corporate-owned life insurance (COLI) arrangements. The benefit formula is the basic starting point in designing or explaining a nonqualified deferred compensation plan.

In which type of nonqualified plan is an employee able to enjoy the growth of an equity position without owning the underlying stock.

- Phantom stock plan A phantom stock plan is a way to give key employees benefits that are measured by the value of company stock without actually giving them stock. Phantom stock comprises units analogous to company shares, with a value generally equal to the full value of the underlying stock.

What is economic benefit?

- Provides a current economic benefit to an employee that can result in current taxation, even if the employee has no current right to receive cash or property.

An employer has offered his employee a below-market loan. The below-market loan rules between an executive and his company will not apply to a compensation-related loan for any day on which the amount of all loans between the executive and his company does not exceed a certain amount. Which of the following is that amount?

$10,000 The below-market rules for a loan between an employer and his employee are applicable if the amount does not exceed $10,000. Such loans are called de minimis loans.

Anna works at Infotech Inc. She draws a salary of $120,000 per year. She is covered under the deferred compensation plan installed by Infotech. The plan drawn up by Infotech includes the following clauses:a penalty haircut provision of 7% for every pre-retirement withdrawal; an allowable hardship withdrawal three times until retirement; and up to a limit of 25% of the accumulated plan balance. Anna has an accumulated plan balance of $26,000 in January 2011. She now wants to buy a house and would like to withdraw from this plan as one source for the down payment for the purchase. What is the maximum amount she gets to use for this purpose?

$6,045 The maximum amount that Anna can withdraw from her plan for her proposed house purchase is $6,500 at a time. Out of this she can utilize only $6,045 after the haircut provision. That is, she will withdraw 25% of $26,000 and use the amount remaining after the 7% haircut penalty.

Audrey is an employee of the Spencer Corporation. She borrows $250,000 from her employer. The applicable federal rate of interest for the first year is $16,000. The actual interest under the loan agreement is only $7,000. This loan results in additional taxable compensation income to Audrey for the first year of $9,000. What is the amount deductible by her employer?

$9,000 The amount deductible by Audrey's employer is $9,000. This would be the difference between the applicable federal rate of interest less the actual interest under the loan agreement, that is, $16,000 less $ 7,000. The employer is treated as if it paid the additional compensation to the employee.

The below-market loan rules between an executive and his company will not apply to a compensation-related loan for any day on which the amount of all loans between the executive and his company do not exceed which amount?

- $10,000 The below-market loan rules between an executive and his company will not apply to a compensation-related loan for any day on which the amount of all loans between the executive and his company do not exceed $10,000.

What is a stock option?

- A company grants the employee an option to purchase stock at some time in the future at a specified price.

What are stock appreciation rights?

- A plan that gives an employee a stake in a company's growth (as reflected in its stock price) without actually investing in the company's stock.

What is a salary reduction formula?

- A plan that involves an elective deferral of a specified amount of the compensation that the employee would have otherwise received.

What is an excess benefit plan?

- A plan that provides benefits only for executives whose annual projected qualified plan benefits are limited under the dollar limits of Code Section 415.

What are the characteristics of a health reimbursement arrangement?

- A self-employed individual in not eligible to contribute.

What are the characteristics of a medical savings account?

- A self-employed individual may contribute if they maintain a high-deductible health plan.

What is a salary continuation formula?

- A type of nonelective nonqualified deferred compensation plan that provides a specified deferred amount payable in the future.

Janet is a successful executive in ABC Inc. ABC Inc. feels that the time has come to provide Janet with some additional retirement benefits. Which of the following are advantages of a nonqualified plan that would prove beneficial to both?

- ABC Inc. can provide Janet with an unlimited benefit, subject to the reasonable compensation requirement for deductibility. - ABC Inc. need not consider nondiscrimination requirements. - ABC Inc. has the flexibility to provide different benefit amounts for different employees, on different terms and conditions. With a nonqualified plan, ABC Inc. has the freedom to decide who to include in the plan. It also has the flexibility to make variations in the amounts for different employees, on different terms and conditions. Janet can receive an unlimited benefit, subject to the reasonable compensation requirement for deductibility. Both Janet and ABC Inc. stand to benefit from a nonqualified plan, as it offers a deferral of taxes on Janet's income and ABC Inc.'s deduction. ABC Inc. will not need to consider nondiscrimination requirements. However, ABC Inc.'s tax deduction will be available to them only in the year when Janet's income is taxable. This may take up to 30 years or more.

What is a constructive receipt?

- An amount is treated as received for income tax purposes if it is credited to the employee's account, set aside, or otherwise made available.

What is a nonqualified deferred compensation plan?

- An employer retirement savings plan for employees that does not meet (ERISA) requirements applicable to qualified pension and profit sharing plans.

Which of the following statements are true for employee stock purchase plans?

- Purchase of stock is brought about by deductions in salary. - The offering period ranges from 3 to 27 months. - ESPPs are tax qualified under Section 423.

Chairman and owner of Winger Corporation, Jack Winger, would like to reward Denise for her hard work and perseverance. In 2010, she is granted non-qualified stock options of 1,000 shares of the company stock at $20 per share, the market value for the shares that year. She can use this option within the next three years. In 2011, Denise purchases 500 shares for a total of $10,000. If the fair market value of the shares in 2011 is $13,000, she has $3,000 of ordinary income in 2011. Denise re-sells the stock at a later point in time at $ 15,000. What tax implications would apply to both Denise and Jack Winger as a result of these transactions?

- As a result of the sale of stock, Denise has capital gains income. - Winger Corporation gets a tax deduction of $3,000 in 2011. - Denise reports a capital gain of $2,000. When Denise sells the stock she has a capital gain income of $2,000. Winger Corporation has a tax deduction of $3,000, as that is Denise's ordinary income amount. The corporation does not get a further tax deduction, as this rule is not applicable to nonqualified stock options. Denise would report a capital gain of $2,000, that is, the difference between the selling price and her basis of $13,000.

What are the advantages of a nonqualified stock option plan?

- As there are few tax or other government regulatory constraints, these plans can be designed to suit the executive or the employer. - Income from the sale of these stocks can be eligible for preferential capital gains treatment. - These plans have little or no out-of-pocket cost to the company. - In the case of nonqualified stock options, tax to the employee is usually deferred at grant. The employer has the flexibility to design the plan to suit both himself or herself and the employee. The company bears little or no out-of-pocket cost for these plans. For the employee, tax is generally not payable at the time when a stock option is granted. Taxation occurs when the option is exercised.

Bob is an employer and Rob is an employee. Rob is participating in a non-qualified plan. As a result of this, which of the following consequences are possible?

- Bob will be taxed on the earnings of the assets set aside to informally fund the plan. - Rob will be taxed when the benefits are distributed. - When Rob is taxed, Bob can claim an income tax deduction.

What are the characteristics of a stock option?

- Can provide a death benefit - This benefit comes in two forms

Which of the following is considered constructive receipt for income tax purposes?

- Credited to an employee's account - Set aside - Amount is payable in five years An amount is treated as received for income tax purposes, even if it is not actually received, if it is credited to the employee's account, set aside, or otherwise made available. Constructive receipt does not occur if the employee's control over the receipt is subject to a substantial limitation or restriction.

How did Rabbi trusts get their name?

- Early IRS letter ruling involed an arrangement between a rabbi and the employing congregation

Which of the following statements is true regarding Health Reimbursement Arrangements (HRA)?

- Employees do not have to be covered under any other healthcare plan to participate. Employees do NOT have to be covered under any other healthcare plan to participate in a HRA, but self-employed persons are not eligible for this type of health savings account. The qualified medical expenses from an HRA cannot be taken as an itemized deduction on Schedule A.

What are the characteristics of a health savings account?

- Employer contributions are fully deductible and any contributions made on behalf of the employee are fully vested and non-forfeitable.

Typically, a split dollar plan involves an executive purchasing life insurance and naming the employer as beneficiary and owner of the contract. State True or False.

- False Normally, the life insurance policy is owned by the employer who also controls and owns the cash value as well as enough of the death benefit to cover expenses if the executive dies. The balance of the death benefit goes to the executive's beneficiary.

Options are typically granted to an employee as part of their regular compensation. State True or False.

- False Options are typically granted to an employee as additional compensation. They are granted at a favorable price, either below or near the current market value, with an expectation that the value of the stock will rise, making the option price a bargain beneficial to the executive.

Employers need to cover a certain percentage of non-highly compensated employees when setting up a nonqualified deferred compensation plan. State True or False.

- False A nonqualified deferred compensation plan can cover one or just a few employees, and they typically are all highly compensated.

There is never a tax when an employee exercises an incentive stock option. State True or False

- False Exercising incentive stock options may result in alternative minimum tax.

If a split dollar arrangement is treated as a loan transaction, the employer does not have to recognize taxable income. State True or False.

- False If a split dollar plan is treated as a loan, the employer may recognize taxable income as part of the transaction.

An employer that provides interest-free loans to executives must do the same for rank and file employees. State True or False.

- False There are no nondiscrimination rules for executive loan programs. Loans can be provided to selected groups of executives or even a single executive.

Judy is an employee at Watson Inc. The retirement benefits made available to her are subject to restrictions imposed by ERISA and the Social Security benefit bias. Her employer, Sherlock Watson, promises to provide her with a total retirement benefit that is 65% of her final pay. Thus, the actual amount that he would pay her would be the difference between 65% of Judy's final pay and the qualified plan and Social Security recruitment benefits. Under which type of SERP would this be possible?

- Target SERP A target SERP replaces retirement benefits that employees lose as a result of restrictions imposed by ERISA. The employer tries to work this in favor of low-income employees. Hence, the employer promises to provide the employee a total benefit plan that is a set percent of the employee's final pay. The total amount that the employee would receive would be the difference between the stated percentage times the final pay and the qualified plan and Social Security retirement benefits.

A SERP that is formally funded will trigger a current______ to the participant.

- Taxation

Bruce, as an employer, would like to provide Tom with retirement benefits. He is looking at life insurance as a viable option. In which of the following situations could he use the split dollar insurance plan?

- If Bruce would like to provide Tom a life insurance benefit at low cost. - If Tom is in his 30s, 40s, or early 50s. - If a preretirement death benefit for Tom is a major objective, and if Bruce is looking out for an alternative to an insurance-financed nonqualified deferred compensation plan. - If Bruce is seeking a totally selective executive fringe benefit. Bruce could use the split dollar life insurance option if he wants to provide Tom retirement benefits without having to spend too much on it. This option would be ideal if Tom is in his 30s, 40s or early 50's, as the plan requires a reasonable duration so as to build up adequate policy cash values and because the cost to the executive, that is the P.S. 58 or Table 2001 cost, can be excessive at later ages. He can also use it if a preretirement death benefit for Tom is a major objective. He will use this option if he is looking for a totally selective executive fringe benefit. The other situation where Bruce can use this option is when he wants to make it easier for shareholder-employees like Tom to finance a buyout of stock under a cross purchase buy-sell agreement, or to make it possible for non-stockholding employees to effect a one-way stock purchase at an existing shareholder's death.

What are third party guarantees?

- In this arrangement, an external entity agrees to pay the employee if the employer defaults.

Which of the following coverage requirements are applicable to nonqualified plans?

- Independent contractors can be covered in the same manner as an employee. The corporation can discriminate as it sees fit if the plan covers only independent contractors or members of management or highly compensated employees. Independent contractors and directors may be covered in the same manner as an employee.

Assume that an employer makes a large below-market loan available to one of its executives for the purpose of covering emergency medical expenses for a family member. Which of the following accurately describes the income tax consequences of the loan?

- Interest is applied to the loan amount based on the applicable federal rate.

What is a split-dollar insurance?

- It is an arrangement between an employer and an employee where they share the costs and benefits of a policy.

Janice has opted for split dollar life insurance. Which of the following advantages can she benefit from?

- Janice can receive life insurance coverage using her employer's funds. With a split dollar plan, Janice can receive the current value benefit. This means that she can benefit from insurance coverage, using her employer's funds. Janice will either have to pay income taxes under the loan regime or the term cost. In order to be maximally effective, the plan usually needs to remain in effect for a longer period of years. Janice would need to pay income taxes each year on the current cost of the life insurance protection.

Jennifer is the owner of a software corporation. As an employer she would like to enhance the retirement benefits received by Rob, a senior executive in the company. She consults her financial consultant, Randolph, and inquires about nonqualified plans. He tells her that it is indeed a good idea to opt for a nonqualified plan. He also gives her the various other instances where she can use the plan. Which situations would Jennifer be able to use the plan to benefit both Rob and her?

- Jennifer would like to provide Rob with the benefits and at the same time not overshoot the allocated budget. - Jennifer would like to provide Rob a deferred compensation under conditions that are different from those applicable to the junior employees. - Jennifer would be able to convey to Rob that his work in the company is appreciated. She would also be able to put to rest a fear that has troubled her regarding Rob not being content. As an employer, Jennifer can use the deferred plan to her advantage, as she can provide additional benefits to Rob within the company's budget. She need not use the same benefit program for all other employees, that is, the plan gives her the flexibility to decide whom to include for the benefit plan. Also, by using the deferred plan she can make sure that Rob is happy with the working conditions in the company. However, Jennifer will not receive a tax deduction in the year that Rob receives the compensation. The deduction will be deferred until the year that the income is taxable to Rob, and this could take up to 30 years or more.

Josephine, owner of the Walter's garment factory, had opted for the incentive stock option plan for her employees. Now, however, she is of two minds, after her friend Michelle told her that she had probably made a mistake due to this plan's several drawbacks. The drawbacks, according to Michelle, are as follows. Click all that apply.

- Josephine's plan must meet complex technical requirements of Code Section 422 and related provisions. - The employee cannot receive capital gains treatment unless he or she is able to come up with funds to exercise the option. - The employee may incur an alternative minimum tax liability when an ISO option is exercised. It is necessary that the ISO plan that Josephine has planned for her employees meet the requirements of Code Section 422 and other provisions. Under the tax implications for these plans, the employees are not eligible for benefits unless they can make provisions for funds to exercise the option. Also, the employee is liable to incur an alternative minimum tax. According to the tax implications for this type of plan, the employer ordinarily does not get a tax deduction at all. Also, the exercise price must be at least equal to the fair market price when the stock is granted. There is no obligation for it to be equal to the fair market value.

In a Health Savings Account (HSA), family coverage must be greater than or equal to:

- Minimum $2,100 with a maximum out of pocket of $10,500. To be able to participate in a HSA, an individual must be covered under a high-deductible health plan. To qualify for family coverage in 2006, the deductible must be greater than or equal to $2,100, with a maximum out of pocket of $10,500. (For single coverage, these qualifying thresholds are $1,050 and $5,250, respectively.)

Which of the following is true about employee stock purchase plan requirements?

- Must be employee of corporation, its parent or subsidiary - Must be approved by stockholders - The exercise price must not be less than 85% below FMV of the stock - Must be exercised within a specific time period

Julia has opted for the incentive stock option plan provided by the company. How long can the exercise period for such a plan last?

- Not more than ten years According to the ISO tax implications, the plan can be exercised no more than 10 years after the date on which the plan has been granted.

Senior executive Emily Thompson is covered under her company's incentive stock option plan. She is granted an option in 2011 to purchase company stock for $150 per share. In May 2012, she purchases 150 shares for a total of $22,500. The fair market value of the 150 shares in May 2012 is $25,000. In September 2012, Emily sells the 150 shares for $27,500. Emily's taxable gain is $5,000. In such a situation, which of the following are possible?

- The company gets a deduction for the compensation income element. - Emily's compensation income for the year 2012 is $2,500. Under the incentive stock option, the company will get a tax deduction for Emily's compensation income element because the stock was sold before the two-year/one-year holding period. However, it will not receive a deduction for granting Emily an ISO. Emily's compensation income for the year 2012 will be $2,500, that is, the fair market value at exercise less the stock purchase cost.

Which of the following are considered advantages of a nonqualified plan?

- The design is flexible - Minimal governmental regulatory requirements - Can provide deferral of taxes to employees Nonqualified plans have many advantages, such as a flexible design, minimal government regulatory requirements, deferral of employee taxes, use by the employer as "golden handcuffs" that help bind the employee to the company, and some assets set aside in some informal arrangements are available to use for corporate purposes.

What is employer account with employee direction?

- The employee has the right to select investments in the account but must limit them to investments such as equity, bonds and mutual funds.

How does taxation of employer work?

- The employer does not receive a tax deduction until its tax year in which the compensation is includable in the employee's taxable income.

In a split dollar life insurance plan, two parties divide, or "split," the responsibilities and the rights to which of the following?

- The policy premiums, cash values, and death benefits. Split dollar life insurance is an arrangement between an employer and an employee which involves a sharing of the costs and benefits of the life insurance policy. Usually these plans involve a splitting of premiums, death benefits, and/or cash values.

Which of the following options regarding nonqualified plan vesting rules are true?

- The qualified vesting plan rules apply if the plan covers rank-and-file employees. - The qualified vesting rules do not apply if the plan covers a select group of management or highly compensated employees. - For nonqualified deferred compensation benefits to remain tax deferred to the employee, the benefits are forfeitable in full at all times.

Which of the following are features of nonqualified plans?

- These plans provide additional retirement benefits to employees. - The employer has a great deal of flexibility while planning the program. - These plans can discriminate. Nonqualified plans provide employees additional retirement benefits. The plans are not qualified under ERISA requirements. As a result, the employer has freedom while planning the program. The employer can decide who is to be included in the plan. He may want to include only highly compensated employees or members of management. Plan benefits for these groups are forfeitable in full at all times.

What are rabbi trusts?

- This arrangement holds property used for financing a deferred compensation plan, where the funds set aside are subject to the employer's creditors.

What is corporate-owned life insurance?

- This arrangement provides financing for the employer's obligation under nonqualified deferred compensation plans.

What is an employee stock purchase plan?

- This plan enables the employee to buy stock through deductions in the salary in the offering period ranging from 3 to 27 months.

What is a penalty or haircut provision?

- This provision has multiple withdrawal reasons stated, including the request of the participant, but there are penalties for early withdrawal.

What is Hardship withdrawal provision?

- This provision provides withdrawal in case of death, disability or financial emergencies. Rules of Section 401(k) do not apply for this provision.

What is Suspension of participation provision?

- This provision temporarily stops the employee's participation in the plan for a period such as six months after withdrawing money from the plan.

Christopher is an executive working in a software company. One day he approaches Veronica, the company's financial advisor, because he needs some information on the loan programs that the company runs for its employees. During the conversation Veronica tells him the situations in which the company may sanction a loan, such as a loan for a new home if the company moves him to a different city. For which of the following situations would Christopher be sanctioned a loan?

- To pay for his son Michael's college tuition. - To meet the medical expenses incurred during his mother's yearlong illness. - To settle credit card dues. - To purchase life insurance. The company will sanction a loan to pay for Michael's education and to clear the medical expenses that the family had to incur during Christopher's mother's yearlong battle against cancer. It would also sanction a loan if he wanted to buy a life insurance policy. The company will, however, reject the loan for the house in Nevada and for settling credit card dues. According to the company policy, only if Christopher were to move from his current office to a different city would a loan be sanctioned for a new home.

The employer is the owner and beneficiary of the life insurance policies it purchases for participants in the SERP plan. State True or False.

- True An employer purchases life insurance for each plan participant to informally fund the plan. The employer policies are purchased, owned, and payable to the employer.

An excess benefit plan makes up the difference between the percentage of pay that top executives are allowed under Section 415 and that which rank and file employees are allowed. State True or False.

- True Highly compensated employees receive the difference between the amounts payable under their qualified plan and the amount they would have received if there were no benefit limitations under Code Section 415.

What are the characteristics of a phantom stock?

- Units analogous to company shares - Can provide a death benefit

Employees participating in unfunded nonqualified deferred compensation plans are likely to seek ways to increase the security of their promised benefits without jeopardizing the tax deferral that is at the heart of such plans. Which of the following devices is least appropriate for such purposes?

- a secular trust Under the secular trust, trust assets are not subject to the claims of the employer's general creditors. Thus, employees enjoy an even greater degree of security. However, trust contributions are taxable to employees, as a substantial forfeiture risk does not exist. Hence, employees would use these trusts when they are in the lower tax bracket or want to recognize income currently.

Jerry Mason owns a law firm. He maintains the top-hat plan to provide deferred compensation benefits to a group of highly compensated employees. The top-hat plan is largely exempt from most of the ERISA requirements. However, it still needs to satisfy one of the following requirements. Which of the following requirements does it need to follow?

- an ERISA reporting requirement The vesting, participation, and funding ERISA requirements are not applicable to top-hat plans. However, these plans need to satisfy a few of the provisions—the reporting and disclosure requirement and the administrative and enforcement provisions.

Which of the following factors determines the appropriate face amount of insurance coverage? Click all that apply.

- employer's after-tax costs of each participant's retirement benefits - premium funding requirements - the present value of any survivor benefits The appropriate face amount of insurance coverage is determined by the following factors: employer's after-tax costs of each participant's retirement benefits, premium funding requirements, the present value of any survivor benefits and, if preferred, the cost or time value of money.

A nonqualified stock option that has a readily ascertainable fair market value at the time it is granted to an employee will result in taxable ordinary income to the employee:

- in the year the option is granted A nonqualified stock option that has a readily ascertainable fair market value at the time it is granted to an employee will result in taxable ordinary income to the employee in the year the option is granted.

Why has the treasury department and the IRS issued Notice 2002-59?

- stop spread of abusive tax avoidance transaction using split-dollar life insurance. - split-dollar life insurance is where the parties attempt to avoid taxes by using high current term insurance rates, prepayment of premiums, or other techniques to understate the value of taxable policy benefits,

Which of the following requirements must be met to qualify for a mortgage loan exception?

- the loan is secured by a mortgage on the new principal residence of the employee. - the loan is compensation-related and is a demand or a term loan. - the new principal residence is acquired in connection with the transfer of the employee to a new principal place of work and meets the distance and time requirements for a moving expense deduction under Code Section 217.

Keya is participating in a split dollar life insurance plan provided by her company. According to the plan, she and her employer split certain responsibilities and rights. Which of the following can they split?

- the policy premiums, cash values and death benefits Split dollar life insurance is an arrangement between an employer and an employee in which there is a sharing of costs and benefits. These include policy premiums, cash values and death benefits.

Gloria is an employee at Rich Corporation. She has opted for an unfunded nonqualified deferred compensation plan. When will she be taxed on her deferred benefits?

- when the benefits are actually or constructively received In the case of an unfunded nonqualified plan, the taxation would be in the year in which the benefits are actually received. Therefore, Gloria will not be taxed at the time of deferral or when there is no longer any substantial risk of forfeiting the benefits. Also, there would be no taxation when the benefits are vested.

Amy is employed at Abacale Corporation and is a key employee. Abacale has a non-qualified plan for Amy and set aside money into it for her in 2009, 2010 and 2011. In 2012, Amy is allowed to take a withdrawal and does so. In what year may Abacale take a deduction?

2012 Abacale Corporation may take a deduction in the year that Amy takes a distribution, or when the funds are made available, which is 2012.

Fred, a participant in ZZZ nonqualified deferred compensation plan, has passed away. Where will the value of the payments made to Fred's beneficiary be included?

Fred's estate