QBank 9
Which of these statements about restricted stock plans is false? A) They are composed of phantom stock. B) They prohibit the immediate sale of the stock. C) They provide tax advantages to the employee. D) They allow voting rights when stock is awarded.
A) Restricted stock plans are not composed of phantom stocks. They are composed of corporate stocks that are granted to the executive at a discounted price, with the restriction that they may not be sold or gifted until some specified future date. The executive's right to own the stock is restricted until the shares vest (restrictions lapse), so there can be no immediate sale of the stock.
Lucy's employer grants her 500 shares of restricted stock worth $5 per share at the time of the grant. The terms of the restriction require Lucy to remain employed by her company for three more years. After the three-year restriction has been met, the stock is trading at $32.50 per share. How much is Lucy required to report as compensation (W-2) income for the year? A) $16,250 B) $13,750 C) $0 D) $2,500
A) The answer is $16,250. When the stock is no longer subject to a substantial risk of forfeiture, the value of the stock is taxed as compensation (W-2) income to the employee; therefore, she must report $16,250 ($32.50 × 500) of income for the year.
Which of these conditions would postpone the payment of income taxes on compensation in the form of restricted stock? The stock is subject to a substantial risk of forfeiture. The employee makes a Section 83(b) election. A) I only B) Both I and II C) Neither I nor II D) II only
A) The answer is I only. If the restricted stock is subject to a substantial risk of forfeiture, income taxes are postponed. Section 83(b) is elected when the employee wishes to immediately recognize the income.
Sandra, a highly paid executive with ABC Company, is interested in entering into a nonqualified deferred compensation plan with her employer. She wants the plan benefit to be payable at her retirement date. However, Sandra does not want to use any of her current compensation to fund the plan. After analyzing this scenario, what plan should be recommended? A) A supplemental executive retirement plan (SERP) B) A salary reduction plan using a rabbi trust C) A Section 401(k) plan D) A salary continuation plan using a secular trust
A) The answer is a supplemental executive retirement plan (SERP). Sandra would want to implement a SERP. This type of plan is funded by salary continuation (employer money) and will pay the benefit at her retirement. A salary reduction plan would use some of Sandra's money, and she makes too much money for only a Section 401(k) plan to provide her with sufficient retirement income on the basis of preretirement percentage of salary.
Donald receives 500 shares of restricted stock from his employer. The stock had a market value of $25 per share at the time of the grant. If Donald makes a Section 83(b) election with respect to this stock, what is the W-2 compensation income he must report for the current tax year? A) $0 B) $12,500 C) $500 D) $6,250
B) The answer is $12,500. If Donald makes a Section 83(b) election, he must report the fair market value of the stock, less any amount he paid for the stock as compensation (W-2) income for the current tax year ($25 per share × 500 shares = $12,500).
Nonqualified deferred compensation (NQDC) plans may incorporate a salary continuation or salary reduction approach. corporate-owned life insurance. a rabbi trust. A) III only B) I, II, and III C) I and II D) II and III
B) The answer is I, II, and III. All of these funding vehicles or approaches may be used in NQDC plans. NQDC plans generally use either a salary continuation or salary reduction approach. Corporate-owned life insurance policies can be purchased on the employee's life, owned by and payable to the employer to fund the obligation under NQDC plans. A rabbi trust is a trust set up to hold property used for funding a deferred compensation plan where the funds set aside are subject to the claims of the employer's general creditors, thereby adhering to the substantial risk of forfeiture rules.
A supplemental executive retirement plan (SERP) A) must be formally funded. B) is designed to provide a specified percentage of retirement income to the executive without regard to the Section 415 benefit limit. C) is a qualified salary continuation plan. D) is funded entirely with employee dollars.
B) The answer is is designed to provide a specified percentage of retirement income to the executive without regard to the Section 415 benefit limit. A SERP is a prototypical nonqualified salary continuation plan designed to provide a specified percentage of retirement income to the executive without regard to the Section 415 benefit limit. A SERP may be unfunded or informally funded. This plan can protect the executive from involuntary termination if the company changes ownership by awarding him increased benefits from the plan, and it is funded entirely with employer money.
Which of these statements pertaining to nonqualified deferred compensation plans is CORRECT? The salary continuation approach uses some portion of the executive's current compensation to fund the promised compensation benefit. With a pure deferred compensation arrangement, the plan is funded with money the employer has set aside from current earnings to benefit the executive in the future. A) I only B) Neither I nor II C) Both I and II D) II only
B) The answer is neither I nor II. The pure deferred compensation arrangement uses some portion of the executive's current compensation to fund the promised compensation benefit. With a salary continuation approach, the plan is funded with money the employer has set aside from current earnings to benefit the executive in the future.
The doctrine of constructive receipt is A) triggered if there is an irrevocable transfer of funds made on the executive's behalf that provides a benefit to the executive. B) triggered if an executive has the right to access the funds or if the funds are securely set aside for the executive without risk of forfeiture. C) also called the economic benefit rule. D) triggered if an executive has control to receive income within stated limits.
B) The doctrine of constructive receipt is triggered if an executive has the right to access the funds or if the funds are securely set aside for the executive without risk of forfeiture. Constructive receipt is different than the economic benefit rule. The economic benefit rule is triggered if there is an irrevocable transfer of funds made on the executive's behalf that provides a benefit to the executive. There is no constructive receipt if income is available only upon surrender of a valuable right or if there are limits on the right to receive the income.
Which of these statements regarding nonqualified stock options (NQSOs) are CORRECT? NQSO grants are inflexible. There are no special IRC requirements for NQSOs. The NQSOs can be gifted to a family member or a qualified charity before the options exercise date. A) I and III B) II and III C) I, II, and III D) I and II
B) There are no special requirements under the IRC for NQSOs. A viable planning technique is for the employee/executive to gift the NQSO to either a family member or qualified charity before the option's exercise date. NQSOs are very flexible, as employers may grant an employee an NQSO on any terms, exercisable over any period of years.
Which of these are characteristics of a supplemental executive retirement plan (SERP)? A) It must be informally funded. B) It rewards an executive's early separation from service. C) It may be established to protect the executive from involuntary termination if the company changes ownership by providing increased benefits from the plan. D) It provides benefits to executives below those available from a qualified plan.
C) A SERP provides benefits to executives over and above the benefits available from a qualified plan and is funded entirely with employer funds. The plan can be either completely unfunded (like an excess benefit plan) or informally funded. The plan rewards an executive's continued employment or encourages the early retirement of the executive. A SERP also may be established to protect the executive from involuntary termination, if the company changes ownership, by awarding them increased benefits from the plan.
Joaquin was granted enough nonqualified stock options (NQSOs) to purchase 10,000 shares of Nova, Inc., stock at $10 per share two years ago. He is fully vested in the options. Which of the following are income tax consequences if Joaquin gifts the NQSOs to a qualified charity before the option's exercise date? Joaquin does not recognize any gain on the transfer. Joaquin will receive a charitable income tax deduction in the year of the gift. Joaquin will be taxed at ordinary income rates if the charity exercises the options while he is living. A) I and III B) I and II C) I, II, and III D) II and III
C) Joaquin does not recognize gain on the transfer date. He will have ordinary income if he is living when the charity exercises the options. Joaquin will be allowed a charitable income tax deduction on the date of transfer because he is fully vested in the options.
Which of these statements regarding employee stock purchase plans (ESPPs) is CORRECT? The option price must be at least 85% of the FMV of the stock at the time of the grant. If an employee separates from service, she must wait three years to exercise the options in an ESPP. No employee can acquire the right to buy more than $100,000 of stock per year, valued at the time the option is granted. A) I and III B) III only C) I only D) I, II, and III
C) The answer is I only. The shares acquired must be held by the employee at least two years from the date of the grant of the option and one year from the date of the exercise.Employees owning more than 5% of the corporation are not allowed to participate in an ESPP. No employee can acquire the right to buy more than $25,000 of stock per year, valued at the time the option is granted.
Which of these statements regarding rabbi trusts are CORRECT? Rabbi trust assets are protected from the employer's creditors. A rabbi trust is a vehicle used to fund benefits for executive employees who are participants in an employer's deferred compensation plan. Taxation occurs to the executive when the payments are received from the trust, and the employer is entitled to a commensurate income tax deduction at the same time. A rabbi trust is identical to a secular trust, except mutual funds are not allowed in the rabbi trust. A) I, II, and IV B) I and II C) II and III D) III and IV
C) The answer is II and III. In a rabbi trust, assets used to fund deferred compensation are placed in an irrevocable trust but are available to the firm's creditors. Both the employer's current contributions and the earned income are not currently taxable to the employee. The employer must still pay tax each year on the trust earnings unless the trust assets consist of cash value life insurance or some similar asset.
Which of these statements regarding a rabbi trust is CORRECT? A) It is a trust used solely and exclusively for religious institutions. B) It is a trust that involves formal funding of the nonqualified deferred compensation (NQDC), thereby making the value of the trust assets immediately taxable to the trust beneficiary. C) It is a trust in which the assets remain available to the claims of the employer's general creditors, thereby constituting informal funding of the arrangement. D) Trust earnings are not currently taxable to the employer.
C) The answer is it is a trust in which the assets remain available to the claims of the employer's general creditors, thereby constituting informal funding on the arrangement. A rabbi trust is an irrevocable trust in which the assets remain available to the claims of the employer's general creditors and is a common method of informally funding an NQDC plan.
Incentive stock option (ISO) requirements include which of these? A) The exercise price of the ISO must be at least 25% less than the market price of stock at the time of the grant. B) The expiration date cannot exceed five years from the date of grant. C) The shares received through the exercise of ISOs cannot be sold within one year from the date of grant and two years from the date of exercise in order to maintain favorable tax treatment. D) ISOs must be part of a written plan approved by the stockholders.
D) ISOs must be part of a written plan approved by the stockholders, and the expiration date cannot exceed 10 years from the date of grant. The exercise price of the option cannot be less than the market price of the stock at the date of the grant. The shares received as a result of exercising the ISOs cannot be sold within two years from the date of grant and one year from the date of exercise, otherwise the favorable tax treatment will be lost.
Which of these statements regarding excess benefit plans is CORRECT? They provide additional retirement income to executives. They provide the executive with the difference between the amounts payable under his qualified plan and the amount that he would have received if the Section 415 plan limitation did not exist. They can discriminate in favor of highly compensated employees. A) II only B) I and III C) I only D) I, II, and III
D) The answer is I, II, and III. Excess benefit plans provide additional retirement income to executives, provide the executive with the difference between the amounts payable under his qualified plan and the amount that he would have received if the Section 415 plan limitation did not exist, and can discriminate in favor of highly compensated employees.
Stock appreciation rights (SARs) A) are used by large corporations. B) award the full value of the stock. C) are similar to junior class shares. D) allow the employee to choose when to exercise the rights.
D) The answer is allow the employee to choose when to exercise the rights. SARs are similar to phantom stock plans except that SARs give the employee/executive a choice of when to exercise his right to share in the appreciation of the closely held company's stock. In addition, with SARs, only the appreciation on the stock is awarded (not the full value of the stock as in a phantom stock arrangement). SARs are often used by closely held businesses that are unable to offer traditional forms of ownership, such as limited liability companies and/or S corporations, which are restricted from having more than 100 shareholders/owners by law.
Which of these statements regarding the substantial risk of forfeiture requirement of nonqualified deferred compensation plans is CORRECT? A) If there is a substantial risk of forfeiture, the deferred compensation will be treated as constructively received. B) If there is a substantial risk of forfeiture, the executive is considered to have current taxable compensation income. C) A rabbi trust qualifies as a substantial risk of forfeiture because the funds set aside for the executive may not be used to satisfy the employer's creditors. D) An unsecured promise to pay qualifies as a substantial risk of forfeiture because there is no guarantee that the executive will receive the deferred compensation.
D) The answer is an unsecured promise to pay qualifies as a substantial risk of forfeiture because there is no guarantee that the executive will receive the deferred compensation. If there is a substantial risk of forfeiture, the deferred compensation will not be treated as constructively received, and the executive is not considered to have current taxable income. A rabbi trust qualifies as a substantial risk of forfeiture because the funds set aside for the executive may be used to satisfy the employer's creditors.
Conway Enterprises, Inc., wishes to set up an equity-based compensation plan that offers the following benefits to employees: Tax advantages Immediate sale of the stock Voting rights when the stock is awarded Shares granted to an employee at no cost or at a bargain price Which of the following would be the best choice for the company? A) Junior class shares B) Severance pay plan C) Stock appreciation rights D) Restricted stock plan
D) The answer is restricted stock plan. A restricted stock plan would offer all the features that Conway is seeking in an equity-based compensation plan.
