Page 262 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

248 The Complete Guide to Executive Compensation

Interest in use of loans was accelerated when the tax court took the position that a bor-
rower incurred no taxable income under an interest-free loan [J. Simpson Dean, 35 T.C.
1053 (1961)]. However, the IRS consistently challenged such arrangements, attempting
to either make the lender pay gift taxes or the borrower pay income tax on the value of the
interest discount. For some time, the courts sided more with the lender and borrower than
with the IRS; however, this changed with the 1984 Tax Reform Act, which stipulates that
most loans in excess of $10,000 (with an interest rate lower than market rates) will require a
charge of imputed income to the borrower.
Loans can still be granted to assist the noninsider in purchasing company stock or financ-
ing a stock option, often after the stock price has dropped and the bank is pressuring the
executive by calling unsecured demand loans—on the assumption that his or her financial
position has deteriorated—or through margin calls on loans for which the stock or other
securities have been pledged as collateral. Company loans may be either recourse or non-
recourse. A recourse loan is backed by collateral (i.e., other than the stock being purchased
with the loan). If the executive fails to meet the scheduled payments, the company can seize
the collateral (at least to the value of the forfeited loan). In a nonrecourse loan, the stock alone
serves as collateral. The company would need to recapture the forfeited amount through
other measures if the forfeited stock value were insufficient to cover the loan. Executives may
also borrow from their stockbroker to buy stock. This is called buying on the margin. See
Chapter 4 for a discussion of the topic.
While acting as banker to executives is an arguably questionable practice, it may be
justified when a company pressures the executive not to sell any company stock holdings.
While some companies charge as much as prime rate for loans, it may be more logical to
reduce the pressure to hold stock, although this runs counter to stock ownership guidelines.
See Chapter 8 (“Long-Term Incentives”).
Other circumstances warranting a company loan range from company-initiated relocation
(either a “bridge” loan to cover equity needs until current residence is sold or an outright loan
that otherwise would be covered by a mortgage) to personal expenses of either a routine (e.g.,
buying a car or financing children’s education) or an emergency nature (e.g., extraordinary
medical expenses).
Other issues the company must address include the following: Who will approve the
loan (e.g., the board of directors)? What is the allowable term? How is the loan paid if the
employee terminates or dies (e.g., balance forgiven, payment schedule unchanged, or payable
immediately)? Is there a maximum amount available for loans? Will conditions and terms
vary by individual?

Financial Planning. Although preretirement counseling often includes some financial
planning, companies can develop a more comprehensive service. Such a service would focus on
minimizing income taxes and maximizing both investment opportunities and estate preserva-
tion. Typically, it begins with a thorough review of the person’s income, expenses, assets, and
liabilities along with the individual’s objectives and investment philosophy. It would also include
a review of the needs of the surviving spouse and other dependents. This leads to establishing
priorities and timelines with forecasted financial positions in stocks, bonds, and real estate.
Performance is tracked and adjustments are made as necessary. Few have the patience, much
less the knowledge, necessary to undertake and complete such a process without assistance from
a qualified professional. The service is expensive one-on-one but more manageable when
packaged in workshops and a limited one-on-one discussion of perhaps an hour.