Page 361 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 7. Short-Term Incentives 347

incentives in the early stages of market development than their publicly held counterparts
because of greater limits on long-term incentives (namely, no publicly traded stock).

Accounting, Tax, and SEC Implications
The accounting rules for short-term incentives are basically simple and straightforward.
The cost is an expense and taken as a charge to earnings in the income statement (typically
identified as “selling, general, and administrative expenses”).
Unlike employee benefits and perquisites (see Chapter 6), taxation is rather simple. The
payment is 100 percent taxable as income to the executive and 100 percent tax deductible to
the company. For those items that are paid in subsequent years, an accrual is established to
retire a liability charge on the balance sheet since the company cannot take a tax deduction
until the executive has taxable income. An exception to this rule is that if payment is made
within 75 days of the close of a calendar year, it may be charged to the previous year for
tax purposes. This is one reason why companies hurry to ensure they pay year-end bonuses
within the prescribed window.
While there is no federal law requiring shareholder approval of the incentive plan,
some states have requirements for companies incorporated under their laws. Similarly, the
stock exchange on which the company stock is listed may have such a requirement. The
Securities and Exchange Commission (SEC) also requires shareholder approval of plans
using company stock.
The reader is again reminded not to rely on accounting, tax, or SEC statements in this
chapter. One needs to seek appropriate professional counsel for such guidance. Statements
made in this chapter and elsewhere are offered as being illustrative to help frame such
further investigations by the reader with counsel.

Plan Types
Essentially, short-term incentive plans come in three varieties: payout based on group
performance, individual performance, or a combination of the two. One of these variations
can form the basis for individual payment and/or determining a fund from which individual
payment would be made. All will be reviewed later in this chapter. The remainder of
the chapter also examines eligibility, relationship of award size and performance, form and
timing of payment, funded and nonfunded plans, and special bonus awards.

Eligibility
Eligibility for short-term incentives is normally determined by one of the six methods
described in Chapter 5 (“Salary”): key position, salary, job grade, job title, reporting relation-
ship (organization level), or a combination of two or more methods.
Key Position. The key position approach examines each job to determine if it should be
included in the incentive plan. Administratively, this has two drawbacks. First, it is possible
that two jobs in the same salary grade will be treated differently—one eligible for bonus,
the other not. Normally, this would require discounting the salary structure for the bonus-
eligible by at least a portion of the bonus—usually the normal or minimum award. Second,
it will be necessary to review the list of eligibility on almost an annual basis for appropriate
additions and deletions. This approach is generally more prevalent among small than among