Page 94 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

80 The Complete Guide to Executive Compensation

Should the company use company stock to fund a rabbi trust (still keeping it available
to general creditors), the company can avoid variable accounting if it pays it out in compa-
ny stock according to the Financial Accounting Standards Board’s (FASB) Emerging Issues
Task Force (EITF). However, as stated in EITF Issue 97-14, should it be converted to
cash, then there will be a charge to the income statement for the appreciation in value over
the period.

Qualified vs. Nonqualified
Qualified plans are so named because they qualify for favorable tax treatment under the IRC.
The most common forms of qualified deferrals are pension plans (Sections 401–420 of the
IRC) and stock options (Sections 421–424 of the IRC). For pension plans, the employee’s tax
liability is deferred until benefits are actually received, even though the company receives a tax
deduction at the time it makes a contribution to the plan. For stock options, the employee is
not taxed until the stock is sold (rather than when it is received).
A nonqualified plan is one that does not qualify for special tax treatment. The employee
is taxed when the amount is received, and the company has a tax deduction at that time in
like amount. The most common forms are pension plans, severance payments, and stock
options.
Severance plans, along with both qualified and nonqualified pension plans, are reviewed
in Chapter 6 (“Employee Benefits and Perquisites”). Stock options, both qualified and
nonqualified, are reviewed in Chapter 7 (“Long-Term Incentives”).
Questions to be answered for nonqualifed plans (and to the extent permitted with
qualified plans) include the following:

1. Who is eligible? If not all employees, who is eligible? This goes back to the definition
of an executive covered in Chapter 1. Typically, eligible persons would include those
who might receive a short-term incentive. However, as the eligibility for such plans is
pushed further down in the organization, some additional definition will be required.
2. What portion of current pay may be deferred? In addition to short-term (and long-
term) incentives, plans may permit deferral of portion of salary. In case of incentives,
the full amount may be deferrable, but for salary, there may be a limit expressed either
as a percentage of salary, dollar annual amount, or some combination of the two. It may
also be stated in terms of amounts in excess of the Employer Retirement Income
Security Act (ERISA) limits. Section 401 prescribes the limit on pay that may be used
for benefits. Section 402 states the limit of pretax 401(k) benefits. And Section 415
states the annual limit to defined contribution plans and the annual benefit limit from
defined benefit plans.
3. What portion of deferral is optional vs. mandatory? Deferrals may be mandatory,
voluntary, or a combination of the two. Mandatory deferrals typically apply to a por-
tion of annual incentive, when used, and only for a limited period of time (e.g., three to
five years). The rationale is to lock the individual into staying. Such plans are not as
frequently used as they once were because companies realized that outstanding per-
formers could always be bought out, leaving them only with locked-in average perform-
ers. Voluntary-only deferrals are the most common and are permitted because they are
attractive to the executive. A combination of mandatory and voluntary deferral could
be designed but is uncommon.