Page 107 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 3. Current versus Deferred Compensation 93

(e.g., 7 percent), a noncompany index (e.g., prime passbook savings or 90-day treasury
notes), or a company index (e.g., return on assets, investments, borrowed capital, or
shareholder equity). The latter two approaches may make an additional adjustment
(e.g., prime rates less 1 percent or one-half the rate of return on shareholder equity). In
addition, two or more of these can be placed in a combination (e.g., prime or one-half
return on equity, whichever is lower).
In using rates, it is important to identify when the measurement will be taken and
how long it will be in effect. For example, using 90-day treasury notes, one could agree
that the averages for the last weeks in March, June, September, and December would
be the applicable rates for the respective quarters. For reference to company data, it
logically would be calculated after the close of the year.
2. The buildup in deferred compensation resulting from an interest rate or other inflation
factor is currently considered compensation when received. However, the increase
might be ruled unreasonable compensation and therefore not deductible by the corpo-
ration. It would seem the risk of this occurring is greatest when the value increases at a
rate significantly greater than an after-tax investment.
3. The tax situation must be thoroughly reviewed on a state as well as federal basis to
ensure it results in lower taxes. Beginning in 1996 in accordance with the Source Tax
Act (Public Law 104-95), no state may tax retirement income of a person not a resident
of the state. Prior to this law, states taxed the person upon receiving benefit even
though the individual no longer lived or worked in that state. Nonetheless, future tax
increases may more than offset all other advantages.
4. An unfunded plan makes the executive a general creditor of the company and
therefore the executive risks nonpayment. While every company expects to exist in
perpetuity, there are enough bankruptcies each year to require an assessment of the
probability of this occurring to the company in question. Establishing a trust with-
out forfeiture requirements will probably mean the executive will be taxed when
money is deposited in the trust; including a forfeiture clause will probably defer
income tax liability to the executive; however, the company may not be able to take
a tax deduction until monies are paid from the trust (thereby resulting in negative
cash flow).
While bookkeeping reserves may be established, no funds can be set aside to meet
the obligation. Furthermore, no annuity contracts or life insurance policies can be pur-
chased for the employee; however, it is possible that such might be accomplished by the
employer as long as the latter retained full ownership and the proceeds were not direct-
ed toward fulfillment of the deferral obligation.
5. Deferred compensation plans increase the administration requirements of the company.
Much of this can be minimized by computer programs unless plans are individually
customized.
6. The 2002 Sarbanes-Oxley Act prohibits the trading of company stock by directors and
executive officers during the blackout period of company benefit plans.
7. The 2002 Sarbanes-Oxley Act also requires the forfeiture of CEO and CFO bonuses,
incentive compensation, and stock gains during the 12-month period following the
restatement of financial statements because of misconduct, thereby affecting any such
payments deferred.
8. The deferred compensation plan, especially if funded, may come under the definition
of a security as defined by the Securities Act of 1933 and the Securities Exchange Act