Executive compensation has evolved dramatically in recent years — in creativity, complexity and dollar value. How so? Stock options, deferred compensation, fringe benefits and other noncash alternative forms of compensation are becoming increasingly popular, comprising larger and larger parts of executives’ overall compensation packages.
Why is the IRS taking note? There are multifaceted tax implications, including income and employment tax issues for both the employer paying the compensation and for the executive employee receiving the remuneration. The increasing use of noncash compensation and the use of partnerships and trusts — both domestic and offshore — add considerable complexity in determining current- and future-year tax liabilities for executives and employers.
Let’s take a look at some of the noncash compensation and what IRS agents ponder in tax examinations:
Nonqualified deferred compensation plans are agreements, methods or arrangements between an employer and an employee to pay compensation in the future. Employers generally deduct expenses only when income is recognized by the employee. The four categories are as follows:
- Salary reduction arrangements defer the receipt of compensation by allowing the participant to defer receipt of a portion of salary.
- Bonus deferral plans resemble salary reduction arrangements, but enable participants to defer receipt of bonuses.
- Top hat or supplemental executive retirement plans are maintained primarily for a select group of management or highly compensated employees.
- Excess benefit plans provide benefits solely to employees whose benefits are limited under employers’ qualified plans.
Unfunded and funded NQDC plans. In unfunded arrangements, the employer promises to pay deferred compensation benefits in the future. A funded arrangement generally exists if assets are set aside from the claims of the employer’s creditors — for example, in a trust or escrow account. If the arrangement is funded, the benefit is likely taxable.
NQDC plans may be formal or informal, but must be in writing. The plan must comply with operational requirements — not only must it be a valid NQDC arrangement on paper, it must also operate according to the plan’s provisions.
Fringe benefits. Any property or service that an employee receives in lieu of or in addition to regular taxable wages may be subject to taxation if provided in connection with performance of services. Among such services are qualified employee discounts, qualified moving expenses, qualified transportation fringes and qualified retirement planning services.
Among fringe benefits are athletic skyboxes/cultural entertainment suites, awards and bonuses, club memberships, corporate credit cards, personal use of a company car and executive dining room privileges. Additional examples are outplacement services, security-related transportation, spousal/dependent life insurance, chauffeurs, employer-paid parking, relocation expenses and noncommercial air travel. Employer-paid vacations, spousal or dependent travel, wealth management, and even an employer paying the employee’s share of FICA taxes round out the IRS’s list.
Golden parachutes. An excise tax of 20 percent is imposed on the recipient of such a payment, and the payer must withhold the tax if the payment is wages.
The 2017 federal tax overhaul doesn’t alter the existing tax rules for nonqualified deferred compensation plans. Early versions of the bill targeted the repeal of a number of popular employer-provided benefits — qualified education assistance, dependent care assistance and adoption assistance programs — but none of the proposals were enacted. However, new changes may crop up, and even the current field is complex, so be sure to stay in touch with your tax and finance professionals.