Taxation Smartbook Ch. 12

Employers are generally allowed to deduct reasonable compensation paid to employees, but the level of deductible compensation is limited to a maximum of $ for the CEO and the next four highest paid employees of publicly traded corporations unless certain exceptions are met.

1,000,000

Van Winkle received stock options from his employer, RiP, Inc. The options entitled Van to purchase 100 shares of RiP common stock at an exercise price of $20 per share. The options vested when the market price of the stock was $32 per share. Van exercised his options on the vesting date. He sold the stock several months later for $38 per share. What is the total bargain element on Van's stock?

1,200 Reason: ($32-$20) x 100; $12 x 100 = $1,200

Tyler has a 28 percent marginal tax rate. His employer is willing to provide health insurance coverage for Tyler if he will agree to a salary reduction. The insurance will cost the employer $5,040. If Tyler pays that same amount for health insurance premiums, he will need $7,000 in order to pay the premiums and the taxes on the compensation. How much of a cash flow savings is available to the company if it pays $5,040 for Tyler's health insurance, rather than $7,000 in compensation assuming the company has a 35 percent tax rate?

1,274 Reason: ($7,000-$5040) x (1-.35) = $1,274

Which of the following nontaxable fringe benefits have a maximum dollar amount that is NOT subject to tax? (Check all that apply.)

1. Dependent care benefits 2. Qualified transportation fringe benefits 3. Employee educational assistance

Which of the following choices are characteristics of stock options? (Check all that apply.)

1. Employees may exercise their options by paying the strike price to the employer anytime between the vesting and expiration dates. 2. Employees may choose NOT to exercise their options if the market value of the shares is below the strike price.

Which of the following fringe benefits are nontaxable fringe benefits for the recipient? (Check all that apply.)

1. Employer-paid premiums on a $50,000 group-term life insurance policy 2. The cost of meals and lodging that is for the convenience of the employer 3. Employer-paid health insurance

Which of the following characteristics apply to taxable fringe benefits? (Check all that apply.)

1. Employers treat the taxable fringe benefits the same as cash compensation. 2. The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee.

Which of the following choices describes disadvantages to the company of offering equity-based compensation in place of cash compensation? (Check all that apply.)

1. The number of shares outstanding increases which causes earnings per share to be diluted. 2. There is an opportunity cost of selling the stock to employees at a discounted price rather than selling it for fair market value on the open market.

A allows employees to choose their fringe benefit package up to a determined amount from a menu of options. The employee may receive cash in lieu of forgone benefits.

1. cafeteria 2. plan

The bargain element is equal to the difference between the price and the fair value of the acquired shares on the date of exercise.

1. exercise or strike 2. market or fair market

A allows employees to choose their fringe benefit package up to a determined amount from a menu of options. The employee may receive cash in lieu of forgone benefits.

1. federal income tax 2. FICA taxes

Employees must pay which of the following taxes on taxable fringe benefits? (Choose all that apply.)

1. federal income tax 2. FICA taxes

By making a Section 83(b) election, the employee is taxed on the value of the restricted stock on the date, rather than the date.

1. grant 2. vesting

For both incentive stock options and nonqualified stock options, there are no tax consequences on either the date or the date.

1. grant or granting 2. vesting, vest, or vested

Taxable fringe benefits are subject to both federal tax and tax.

1. income 2. FICA or payroll

The bargain element is taxed as ordinary income on the exercise date for stock options, but NOT for stock options unless specific required holding periods are not met.

1. nonqualified or NQO 2. incentive or ISO

Employees who receive compensation in the form of stock do not have to pay for it, but forfeit ownership if they quit before the date.

1. restricted 2. vest

The type of compensation where employees receive a fixed amount regardless of the amount of hours worked is called a(n) . The type of compensation that is based on the number of hours worked is called . Both types of compensation are taxed to employees as income and are subject to tax which includes Social Security and Medicare.

1. salary 2. wage 3.ordinary 4. FICA

Nontaxable fringe benefits are very attractive to employees because their after-tax cost for these benefits is . The cost of the benefits is (nondeductible/deductible) for the employer.

1. zero, 0, or nothing 2. deductible

Tyler earns $80,000 per year and has a 22 percent marginal tax rate. His employer is willing to provide health insurance coverage for Tyler if he will agree to a salary reduction. The insurance will cost the employer $4,680. How much salary should Tyler be willing to forgo to receive the $4,680 in health insurance coverage?

6,000 Reason: $4,680/(1-.22) = $6,000

How is restricted stock taxed to employees receiving the stock?

Absent an election, employees are taxed at ordinary rates on the full market value of the shares on the date the restricted stock vests.

Which one of the following statements is INCORRECT when referring to flexible spending accounts (FSAs)?

Any money in the account at year end may be withdrawn and is taxable to the employee when received.

Which of the following statements is INCORRECT regarding compensation expense for employers in publicly traded corporations?

Companies are only allowed to pay compensation of $1 million each to the top four executives.

Why do employees prefer ISOs to NQOs?

Employees who meet the required holding period for ISOs will treat the difference between the sales proceeds and exercise price as a long-term capital gain.

Which of the following statements is INCORRECT regarding the timing of employer deductions for compensation and the employees' inclusion of compensation in gross income?

Employers must deduct the compensation the same year that the employees include the amounts in gross income regardless of the accounting method.

Which of the following statements is correct regarding employers' treatment of salaries and wages?

Employers using the accrual method of accounting must deduct salaries and wages in the year the employees earn the compensation.

Which of the following choices is NOT an advantage of equity-based compensation?

Equity-based compensation is exempt from taxation for the employees.

What is the advantage of having a cafeteria plan over a standard package of benefits?

In a cafeteria plan, the employee can choose the benefits that are best suited to his or her situation.

Concerning employees, which of the following statement is INCORRECT when considering fringe benefits?

Taxable fringe benefits are generally available to all employees on a nondiscriminatory basis.

How is the amount of the employer's tax deduction for restricted stock determined?

The amount of the deduction equals the ordinary income that is recognized by the employees.

Which one of the following characteristics applies to taxable fringe benefits?

The cost of the taxable fringe benefit is deductible to the employer, not the value of the benefit to the employee.

What is the tax treatment for the employer when restricted stock is granted to employees?

The deduction equals the ordinary income recognized by the employee and the timing is based on whether or not Sec. 83(b) is elected.

Which of the following choices is a characteristic of restricted stock?

The employee is not required to pay for the stock but rather is given the shares on the grant date.

What is the tax treatment of nonqualified stock options for employers?

The employer deducts the bargain element of the option on the date the employee exercises his/her options.

What is the tax treatment of incentive stock options for employers?

The employer does NOT receive a tax deduction for incentive stock options.

Which of the following statements is INCORRECT when describing the advantages and disadvantages of making a Section 83(b) election for restricted stock?

The market value of the stock is taxed at the lower capital gains rate on the grant date.

Why are nontaxable fringe benefits attractive to both the employer and the employees?

The net after-tax cost to employees is zero and the employer receives a tax deduction for the cost of the benefit.

Which of the following statements is correct when describing the tax treatment to the employees of stock options?

There are no tax consequences on the grant date or the vesting date for both ISOs and NQOs.

Which one of the following choices describes a disadvantage to the company of offering equity-based compensation?

There is an opportunity cost of selling the stock to employees at a discounted price, rather than selling it for fair market value on the market.

True or false: Employees prefer to receive ISOs rather than NQOs because any gain on the subsequent sale of the stock may be taxed as a long-term capital gain if the required holding periods are met.

True Reason: NQOs are taxed differently. The bargain element is actually taxed as ordinary income on the exercise date which can present a cash flow shortage for those purchasing the stock.

Van Winkle received nonqualified stock options (NQOs) from his employer, RiP, Inc. The options entitled Van to purchase 100 shares of RiP common stock at an exercise price of $20 per share. The options vested when the market price of the stock was $32 per share. Van exercised his options on the vesting date. He sold the stock two years later for $48 per share. Which of the following choices is correct?

Van's gain on the sale will be a $1,600 long-term capital gain recognized on the sale date. Reason: Van's basis in the stock is $32 because he would have paid tax on the bargain element on the exercise date.

Van Winkle received incentive stock options (ISOs) from his employer, RiP, Inc. The options entitled Van to purchase 100 shares of RiP common stock at an exercise price of $20 per share. The options vested when the market price of the stock was $32 per share. Van exercised his options on the vesting date. He sold the stock two years later for $48 per share. Assuming he meets the required holding periods to qualify for the tax treatment afforded incentive stock options, which of the following choices is correct?

Van's gain on the sale will be a $2,800 long-term capital gain.

A small benefit received from working in a company, such as the freedom to make a few personal copies or use the fax machine, is referred to as a:

de minimis fringe benefit

Accounts in which employees are allowed to set aside a portion of their before-tax salary to pay either health and/or dependent-care benefits are called:

flexible spending accounts

Employees receiving restricted stock are taxed on the fair market value of the shares on the date (absent an election).

vesting