Page 103 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 3. Current versus Deferred Compensation 89

• Election does not take effect until at least 12 months after election date
• Election related to payment is deferred for a period of not less than five years from
the date such payment would have been made (disability, death, and unforeseen
emergency exempted)
• Election to change specified time or stated fixed schedule is not made less than 12
months before first scheduled date
Regulations exclude the following:

• Indemnification arrangements and legal settlements
• Educational benefits
• Reasonable outplacement expenses and reasonable moving expenses following
separation of service
• Separation pay if the lesser of two times annual compensation or the limit set in
Section 401 (a) (17) and following a six-month-delay requirement for specified
individuals.

Noncompliance with the Act

All compensation deferred for the present year and preceding years (not subject to substan-
tial risk of forfeiture) is included in gross income and in addition to income tax is subject to
a 20 percent tax penalty plus an underpayment interest tax penalty.

TAX AND ACCOUNTING TREATMENT

Company

The company is expected to take an annual charge to earnings equal to that period’s obliga-
tion to future payment. A reserve on the balance sheet reflects the accumulated liability.
If the deferral is in the form of stock, FAS 123R states that as a full-value award, the value
on date of the restriction will be expensed over the period of restriction (times the number
of shares under restriction) without regard to changes in stock price. However, the company
will not receive a tax deduction on the full value of the stock until the time the restrictions
lapse. If dividends were paid during the period of restriction, they were tax deductible at
that time.
If the deferral is in the form of cash, that amount (along with any interest consideration)
is expensed over the period of restriction. In this regard, the cash plus interest will require a
greater charge to earnings than the restricted stock, whose price is locked in at time of defer-
ral. If the deferral is in the form of stock, it will be dilutive, increasing the number of shares
of stock outstanding and therefore decreasing earnings per share; however, the earnings
charge would be less since it was fixed at the time of deferral. EITF 97-14 states that only by
paying the deferred compensation in company stock can the company lock in the charge at
time of deferral. If it can be paid in cash, then additional expense must be recognized over
the deferred period for this increase in value.
If the individual makes an 83(b) election at time of deferral, the company gets a tax
deduction equal to the amount of the individual’s taxable income. However, the company will
not have a tax deduction at the time the restrictions lapse since the executives’ gain would be
subject to capital gains tax.