Page 99 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 3. Current versus Deferred Compensation 85

should recognize, however, that the IRS may look to an individual’s age to determine whether
continued employment is really a substantial risk of forfeiture. A 60-year-old executive with
30 years of company service (and a handsome pension accruing) is not as likely to depart as,
say, a 40-year-old individual with only five years of service. Secular or nonexempt trusts are
described in Section 402(b) of the IRC. They are irrevocable, nonforfeitable interest in a
trust’s assets with payment made upon date of a specified event (e.g., death, termination of
employment, retirement, or other reasons). Such trusts are subject to certain provisions of
ERISA.

Deferred Is there Is there Tax liability
income to constructive No economic No deferred to receipt
executive? receipt? benefit? of payments

Yes Yes

Current tax Current tax
liability liability
Figure 3-2. Constructive receipt and economic benefit flowchart
The impact of constructive receipt and economic benefit is shown in the flowchart
in Figure 3-2. Revenue Procedure 93-64 should be consulted as it provides “safe harbor”
guidance to avoid constructive receipt and economic benefit problems.

Restricted Property
Prior to the 1969 Tax Reform Act, a number of deferred compensation plans used restricted
property. A typical example would be to give an individual shares of stock in the company
indicating that the restrictions would lapse according to a schedule. For example, an execu-
tive might be given 1,000 shares of company stock (then selling at $100 a share) and told
that restrictions would lapse at the rate of 100 shares a year for the next 10 years. Not only
was there no tax liability at time of grant, but when the restrictions were removed, the value
would be subject to the lesser of the following: ordinary income tax on the fair market value
at time of award, or capital gains tax when the restrictions lapsed. Thus, if the value of
the stock rose, there was a capital gains opportunity; if it dropped, the tax would be based on
the fair market value at time of receipt.
The Tax Reform Act of 1969 added a new section to the Code—Section 83, which deals
with the taxation of property. It states that the fair market value of the property will be that
when the restrictions lapse, at which time it will be considered ordinary income. To delay
recognition of income, the restrictions must include substantial risk of forfeiture. IRC
Section 83(c)(1) states: “The rights of a person in property are subject to a substantial risk of
forfeiture if such person’s rights to full enjoyment of such property are conditioned upon the
future performance of substantial services by any individual.”
However, the recipient may make a Section 83(b) election, not later than 30 days after the
date of such transfer, to include in the recipient’s gross income for the taxable year, the excess