Employee and Executive Compensation and Benefits

Popular Plans to Incentivize and Retain Talent

Employees and executives can get added compensation in addition to their salaries. In some cases, these benefits could exceed the salary. Most of these benefits are contractual and, where there is a discretionary element, it is usually awarded by the board of directors. This article provides a round up listing of the more popular benefits. Not included are standard benefits covering most employees.

Employees and executives can get added compensation in addition to their salaries. In some cases, these benefits could exceed the salary. Most of these benefits are contractual and, where there is a discretionary element, it is usually awarded by the board of directors. Here is a round up listing of the more popular benefits. Not included are standard benefits covering most employees.

Annual bonus: This could be contractual, objective, subjective, discretionary, or paid by custom, and could be paid to almost any level of employee.

Incentive payments: These could be annual or long term and are payments based on meeting predetermined individual, team, group, division or companywide performance or specific overall goals.

Incentive stock options (ISO): These are granted for a specific period with vesting that takes place over a period of years; usually three to five years. The employee is permitted to exercise the option (i.e., purchase the underlying shares) at a price that is fixed when the option was granted. If an employee terminates employment before the vesting date, then she loses the right to the options. There are exceptions if an employee dies while employed or certain other circumstances. Vesting is the date that removes any restrictions on the employee from exercising the option.

The goal is to have the employee remain with the company for at least a certain period. If this is handled properly, the gains are taxed as long-term capital gains.

Stock options other than ISOs: These are also referred to as nonqualified stock options. Here the employee is granted the option or right to purchase the company’s shares for a fixed price as the options become vested, and anytime thereafter until the expiration date. “Nonqualified” means they are not specifically qualified under the Internal Revenue Code (IRC) as the ISOs are.

Restricted stock: The employee is given the stock for no cost, but the shares can only be sold when they become vested. Note that the employee will be taxed on the value of the shares when they vest regardless of whether they are sold at that time or retained. Usually, the employee would sell at least as many shares as necessary to generate the cash to cover the taxes, but that is not a condition of the issuance of the shares. Any sales of shares after one year after the vesting date will be treated as long-term capital gains. There is a special election an employee can make to be taxed when they receive the shares that must be made within 30 days of receiving the shares. For that reason, it is necessary for the employee to consult with a knowledgeable tax advisor immediately upon receiving the restricted stock. This election is made under IRC §83(b) and is beneficial because appreciation upon sale after the vesting date qualifies as capital gains instead of ordinary income (assuming the vesting date is more than one year later). Making this election is particularly important where the stock has the potential to greatly increase in value. For taxes and investment planning, this election must be considered; so it is imperative that a competent tax advisor be consulted immediately upon receiving the stock. Note: some plans provide for a payment or strike price and in those situations, the employee would only get the increase in value and not the entire value when they vest.

Restricted stock units (RSU): These work like restricted stock except the benefit is the right to receive the stock upon or after vesting, and not the immediate issuance of the shares when the units are granted. Here, the holding period will start when the actual shares are transferred and any income upon vesting would be treated as ordinary income. With RSUs, the vesting could also be contingent on another event occurring such as the company being sold, and not just the length of the vesting period. Further, since actual shares are not part of this benefit, dividends paid by the company generally would not be paid with respect to the RSUs.

Phantom stock: These could be called by any number of names. When we advise a client on establishing a phantom stock plan, we suggest calling it something like “stock performance rights” or “stock appreciation rights.” With this, the company gives the employee units that mimic actual stock shares and when vesting occurs, a cash payment is made equivalent to the growth in the value of the company’s shares plus any dividends that have been paid during the grant period. At the point of payment, the employee receives what they would have had they owned the actual stock and then sold it, except all the income is taxed as compensation and there is no opportunity for capital gain treatment. Note: some plans provide for a deferred payment rather than a cash payment when the employee vests, and some plans establish a “base” price and only the growth over that is paid to the employee.

Book value growth: This links payments to growth in book value. This is more common for a private company than for a public company. The public company might issue the benefit based on the growth in value of the company’s shares. See incentive payments above.

Employee stock ownership plan (ESOP): This is a qualified retirement ERISA plan that covers all eligible employees. The employees do not own any stock but participate as members of the ESOP based on their percentage participation in the plan. In some plans the employees can receive the actual shares when they leave the company.

Signing bonuses: These are paid to induce an employee to sign a contract for a period of years and as each annual milestone is attained, a payment is made. An example is: a signing bonus for three years can be paid upfront or it can paid in installments; for example, 1/3 at the end of each of the three years, or 1/6 at the end of the first year, 2/6 at the end of year two, and 3/6 at the end of the third year. Signing bonuses can also be renewed at the end of each bonus period.

Whole life or variable life insurance policies: These policies can be purchased for an employee and are funded annually by the company. The policy would be transferred, along with any cash value, to the employee when they leave the company; usually upon their retirement. If the employee dies before retiring, their beneficiaries receive the death benefit. In these cases, a portion of the insurance benefit is usually taxed each year to the employee.

401(k) plans: These have become extremely popular. Here, an employee elects to have a portion of their salary reduced and deposited into the plan which could be a standard pre-tax 401(k) plan or a Roth after-tax 401(k) plan. There is no current tax benefit to the Roth contribution, but the income accumulates tax-free and the distributions of principal and income would never be taxed if they are not withdrawn prematurely. Many companies also match a portion of the employee’s contribution, and this is an additional benefit to the employee.

401(k) plan stock rollover: Some employers contribute shares of its stock rather than cash as the matching portion. When an employee leaves a company and rolls over the account to an IRA plan owned by the employee, it would be tax free at that time. If the rollover includes employer’s shares that have appreciated in value, the employee can elect not to roll over those shares and to pay tax on those shares based on the value when the employer originally contributed those shares rather than on the net unrealized appreciation (NUA) when distributed. Depending on the employee’s circumstances, this could represent a substantial tax benefit if handled properly. Our advice where a 401(k) distribution includes employer stock is to immediately obtain the advice of a tax expert who would also be able to apply the situation to your personal circumstances.

Each benefit has its own tax consequences and it is recommended that the employee consult with a knowledgeable professional as soon as the benefit is conferred. To take advantage of some benefits, there are actions that must be taken within 30 days of being granted the benefit, so an immediate consultation is extremely important. Further, some plans cause the employee to pay to the employer the withholding that is required for that type of benefit.

The above is a listing of the more popular plans, but there are many others as there are many variations of these plans and occasionally, these benefits are issued in tandem with other plans or with cash to cover some of the tax consequences.

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Edward Mendlowitz, CPA, PFS, ABV, CFF, is emeritus partner with WithumSmith+Brown, PC, in East Brunswick, New Jersey. He has over 40 years of public accounting experience, is a licensed certified public accountant in the states of New Jersey and New York, and is one of Accounting Today’s 100 Most Influential People. The author of 28 books, Mr. Mendlowitz is an award-winning author of over 1500 articles for business and professional journals, newsletters, and blogs and has presented over 350 CPE programs. He writes a twice a week blog at www.withum.com/partners-network-blog.

Mr. Mendlowitz can be contacted at (732) 743-4582 or by e-mail to emendlowitz@withum.com.

Wendy Y. Terry is a partner in Withum’s Florida office. She is licensed as a certified public accountant in Florida, Georgia, Alabama, North Carolina, New Jersey, and Hawaii. She is a member of the American Institute of Certified Public Accountants (AICPA) and the Florida Institute of Certified Public Accountants (FICPA). Ms. Terry has extensive experience working with multinational clients in the manufacturing and distribution industries with a deep understanding of Cost Accounting Standards (CAS) and Federal Acquisition Regulations (FAR), and is also an employee benefit plan specialist.

Ms. Terry can be contacted at (407) 956-5999 or by e-mail to wterry@withum.com.