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Deferred Compensation. Rely on Concept Summaries, 19-2 through 19-4 in Text. Qualified Plans . Pension, profit-sharing, stock bonus and ESOPs, cash balance plans Pensions are either defined benefit or defined contribution plans

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Deferred compensation

Deferred Compensation

Rely on Concept Summaries, 19-2 through 19-4 in Text


Qualified plans
Qualified Plans

  • Pension, profit-sharing, stock bonus and ESOPs, cash balance plans

    • Pensions are either defined benefit or defined contribution plans

  • Must not discriminate in favor of high-paid employees, must cover 21 year-olds and up after 1 year of service.

  • Vesting: cliff after 5 years, graded is 20% after 3 years and fully vested in 7 years.


Some important definitions
Some Important Definitions

  • Defined Contribution Plan

    • Limited to lower of employee’s compensation or $46,000 2008 indexed

  • Includes profit sharing plan, money purchase plan, stock bonus plan, but max limits differ

    • Limited to lower of 25% employee’s compensation or $46,000 indexed

  • Defined Benefit Plan

    • Benefit payable is lesser of $195,000 or 100% of avg. of highest paid 3 years, up to $245,000; $10,000 de minimis floor: 2009

    • Special rules where employee has worked <10 years

    • Must retire at 65 or later (staggered retirement ages)


401 k
401(k)

  • Participant contributes, employer matches portion up to max; 100% vested; tax deferred contributions and earnings

  • Max tax break on $16,500 indexed (2009)

  • Max reduced $-4-$ by tax-sheltered annuities and SEPs

  • If excess exceeded, extra is taxable or may be distributed tax-free before 4/15 of following year.

  • 10% excise tax for excess contributions; possible loss of qualified status

  • Catch-up contributions of extra $5k for those over 50

  • 403(b) similar to 401(k)


Savings incentive match plan for employees
Savings Incentive Match Plan for Employees

  • So named, presumably, because tax legislators get punchy after working long hours during legislative session

  • EZ 401 (k) for Smalls

  • Less than 100 employees, receiving at least $5,000 over 3yr pd including this year may contribute up to $11,500/year, 2009; indexed w/ $2,500 catch-up provision

  • Employee contributes % of compensation; matching of 3% or direct contribution of 2%,

  • Employer deducts up to cost or 25% of compensation paid/accrued

  • Subject to IRA withdrawal rules, except if withdrawn early in first 2 years of employment, subject to 25% penalty instead of 10% penalty


Regular iras
Regular IRAs

  • Established by due date of return; Contributions: due date of return

  • Ltd: $5,000 (2008, indexed) or 100% combined compensation with $1,000 catch-up provision for those over 50.

  • Ltd: reduced by active participation in another plan, but nondeductible contributions can be made which increase (0) basis in IRA. Limitations begin at $85,000 MFJ

  • 10% Penalty for early withdrawal (before 59 ½)

  • Can be rolled over up to once yearly

  • 6% excise penalty on excess contributions


Keoghs
Keoghs

  • Established by end of tax year; Contributions: due date of return

  • Can be defined contribution: ltd. $49,000 ( 2009, indexed) or 100% earned income

  • Profit-sharing: ltd 25% of employee pay (20% if self-employed, after ½ SE)

  • Personal Service business: ltd to earned income

  • Defined benefit: Ltd: smaller of $195,000 indexed or 100% of average highest 3-yrs of compensation

  • Top-heavy: restrictive rules


Roth iras
Roth IRAs

  • Established by due date of return; Contributions: due date of return

  • Same limits and penalties, but no current tax break for contribution; after-tax contribution + earnings are tax-free if withdrawn timely

  • Withdraw after 59 ½, with 5 year holding period

  • High-income phase-out starts at $166,000 2009 MFJ


Coverdell iras
Coverdell IRAs

  • For education, but sometimes lumped with pensions because of the “IRA” title.

  • Max $2,000/year non-deductible contribution for qualified education expenses for minor:

    • Tuition, fees, books, supplies, equipment

    • Room, board if > ½ time

  • If withdrawn for non-qualified expenses, use annuity rule to figure return of capital.

  • Must be withdrawn or rolled over before beneficiary reaches 30

  • AGI Phase-out of $190,000 MFJ, 2008


Simplified employee pension plan
Simplified Employee Pension Plan

  • Useful because of extended set-up deadline (great for small, family-owned procrastinating clients!)

  • Employer contributes up to lesser of $49,000 (2009) indexed or 15% employee’s earned income to individual employee IRAs; For each eligible employee who is 21 or older and been employed 3 of last 5 years


Minimum distribution rules
Minimum Distribution Rules

  • Must begin April 1 in later of year employee is 70 ½ or retirement year, unless Roth (no required distribution date for Roth)

  • Minimum Required Distributions spread over IRS life expectancy

  • 10% penalty on early distribution (before 59 ½, unless due to death, disability, annuity, early retiree who is at least 55, medical expenses or medical insurance premiums, higher ed, first-time home buyers).


Tax on distribution
Tax on Distribution

  • Employee’s basis in annuity returned tax-free

  • Distributions can be rolled over within 60 days tax-free, but with 20% withholding

  • If taxpayer has basis (contributed after-tax $), use annuity calculation to determine amount of distribution excludable from tax

  • Special rules fro pre-1987 lump-sum distributions


Deferred compensation

55. Louise terminated her employment and received a cash distribution from her qualified retirement plan in the amount of $120,000. She made a qualified rollover contribution of $100,000. If her marginal tax rate is 30%, and she is 45 years old, what is the total amount of taxes she must pay on the distribution?

A) $ 6,000

B) $36,000

C) $ 8,000

D) $18,000


Annuity example
Annuity Example distribution from her qualified retirement plan in the amount of $120,000. She made a qualified rollover contribution of $100,000. If her marginal tax rate is 30%, and she is 45 years old, what is the total amount of taxes she must pay on the distribution?

  • Assume an employee invested $10,000 in an annuity that will begin paying $100/mo for the next 30 years. If the annuity begins paying April 1st of this year, how much is taxable?

  • [10,000/($100*30*12)]*(100*9) = Excludable amount

  • $250 of $900 received is excludable; the remaining $650 is includable


Annuity payments unknown
Annuity, # Payments Unknown distribution from her qualified retirement plan in the amount of $120,000. She made a qualified rollover contribution of $100,000. If her marginal tax rate is 30%, and she is 45 years old, what is the total amount of taxes she must pay on the distribution?

  • Assume an employee invested $10,000 in an annuity that will begin paying $100/mo for life. If the annuity begins paying April 1st of this year when the recipient turns 56, how much is taxable?

  • Look up the table, Sec. 72 (d)(3)

  • [10,000/($100*310)]*(100*9) = Excludable amount

  • $290.32 of $900 received is excludable; the remaining $609.68 is includable


Deferred compensation

14. The taxpayer purchased a 10-year annuity for $96,000 late in 2005. The annuity will pay him $4,000 per month for ten years starting on September 1, 2005. How much of the $16,000 received this year will be taxable?

A) $12,800

B) $16,000

C) $ 0

D) $3,200


Corporate deductions for defined benefit pensions
Corporate Deductions for Defined Benefit Pensions late in 2005. The annuity will pay him $4,000 per month for ten years starting on September 1, 2005. How much of the $16,000 received this year will be taxable?

  • Aggregate Cost, + up to 10% past service costs,

  • w/ carryover

  • 10% excise tax on nondeductible contributions


Nonqualified deferred compensation plans
Nonqualified Deferred Compensation Plans late in 2005. The annuity will pay him $4,000 per month for ten years starting on September 1, 2005. How much of the $16,000 received this year will be taxable?

  • …When your executives just don’t make enough…

  • As dependable as the company that is promising to pay you later

  • Employee taxed when payment is made, which is either: separation, disability, death, fixed schedule, change in employer control, unforeseeable emergency

  • May be in the form of “phantom stock options”


Golden parachutes
Golden Parachutes late in 2005. The annuity will pay him $4,000 per month for ten years starting on September 1, 2005. How much of the $16,000 received this year will be taxable?

  • Excess severance pay

  • Deductible to employer unless payment is contingent on change of ownership of corp AND amt of comp > 3x employee’s annual comp.

  • Disallowed amount subject to 20% excise tax


Excess compensation limit
Excess Compensation Limit late in 2005. The annuity will pay him $4,000 per month for ten years starting on September 1, 2005. How much of the $16,000 received this year will be taxable?

  • Only first $1million deductible by publicly-traded corp. unless based on performance


Restricted property plans
Restricted Property Plans late in 2005. The annuity will pay him $4,000 per month for ten years starting on September 1, 2005. How much of the $16,000 received this year will be taxable?

  • Employer transfers property (e.g. stock) at bargain price contingent upon services performed.

  • Employee includes as gross income when substantial risk of forfeiture is removed, or if elected, earlier when restricted property is received


Stock options
Stock Options late in 2005. The annuity will pay him $4,000 per month for ten years starting on September 1, 2005. How much of the $16,000 received this year will be taxable?

  • Right to purchase shares at stated price within stated time period.

  • Generally Incentive Stock options

  • Not included in $1million cap on top 5 executives *if* the options are disclosed, shareholder-approved, and not issued in money.

  • May also be employee stock purchase plan or nonqualified options or restricted property


Incentive stock options
Incentive Stock Options late in 2005. The annuity will pay him $4,000 per month for ten years starting on September 1, 2005. How much of the $16,000 received this year will be taxable?

  • At time of grant: no tax consequences to employee or grantor, because exercise price > FMV, however this difference is a tax preference item for AMT.

  • If option exercised, employee taxed later, when stock is sold, as ltcg. (Employee must hold option for >2 years; stock >1)

    • No deduction for employer

    • Ltd. To $100,000 ISO exercise per year per employee

  • If option lapses, capital loss to employee for amt pd, if any.


Deferred compensation

3. In the current year, employee F is given an incentive stock option (ISO) entitling him to purchase 100 shares of his employer Sigma Corporation’s stock for $50 per share. He exercises the option in the following year when the shares are selling for $80 per share. If F sells these 100 shares four years later for $200 per share, he will recognize

a. a long‑term capital gain of $120 per share.

b. a long‑term capital gain of $150 per share.

c. ordinary income of $30 per share and a long‑term capital gain of $120 per share.

d. no income upon sale.


Non qualified stock options
Non-Qualified Stock Options stock option (ISO) entitling him to purchase 100 shares of his employer Sigma Corporation’s stock for $50 per share. He exercises the option in the following year when the shares are selling for $80 per share. If F sells these 100 shares four years later for $200 per share, he will recognize

  • FMV included in employees income at date of grant

  • That amount plus exercise price is basis against capital gain or loss at sale

  • Employer gets tax deduction equal to *ordinary* amount included in employee’s income.


Stock appreciation rights
Stock Appreciation Rights stock option (ISO) entitling him to purchase 100 shares of his employer Sigma Corporation’s stock for $50 per share. He exercises the option in the following year when the shares are selling for $80 per share. If F sells these 100 shares four years later for $200 per share, he will recognize

  • Rights granted to an employee for appreciation in the value of share price, not actually stock itself.

  • Rights may be paid in cash and/or stock

  • No tax on grant date, but FMV of stock/cash taxes as ordinary income on exercise date

  • Employer takes equal amount as deduction


Rabbi trusts etc
Rabbi Trusts, etc. stock option (ISO) entitling him to purchase 100 shares of his employer Sigma Corporation’s stock for $50 per share. He exercises the option in the following year when the shares are selling for $80 per share. If F sells these 100 shares four years later for $200 per share, he will recognize

  • Rabbi trust: Irrevocable, unsecured, often unfunded, employer-established trust for nonqualified deferred compensation to highly-compensated employees

  • Corporate Owned Life Insurance (COLI): policies that grow tax-deferred and pay at death.