21 st Annual IL Statewide APA Conference

21st Annual IL Statewide APA Conference

August 22, 2014Galley Kitchen Session 52:25-3:55 PM

Sautéing the Taxation of Deferred Compensation, Stock

Options, and Executive Pay

Lori WolfeCompliance MangerPaylocityEmail: [email protected]

21st Annual IL Statewide APA Conference – August 21-22, 2014

Lauren VanDeveerPayroll AnalystPaylocityEmail: [email protected]

Before we beginThe recipe we’re creating has some specialty ingredients, so if you have questions…

Please feel free to ask during the presentation…

…or make note of them for follow up at the end.

Win PrizesComplete your recipe cards as we go along and help us choose some of the ingredients… And you could win prizes.

Let’s get trending!Include #APAStatewide2014 if you post online

about our presentation, and you could win prizes.

A Taste of What’s to Come

• Deferred Compensation• Qualified• Nonqualified

• Stocks and stock options• Employee stock ownership plans• Stock as compensation• Statutory stock options• Nonstatutory stock options

• Executive Pay and Perks

Recipe for Success:Be a smart shopper and prepare the ingredients properly.

Selecting Ingredients Varieties of Deferred Compensation Plans

Qualified Deferred Compensation• Tastes like…• 401(k)• 403(b)• 408(k)• 457• 501(c)• 408(p)


Qualified Deferred Compensation• Found in the Produce section of our grocery store• Subject to nondiscrimination requirements and specific wage

and contribution limits• Funds invested with investment firms• Compliance generally monitored by investment firms annually• Spoiling results in losing the tax exempt status


Qualified Deferred Compensation• How to identify spoiled product• Fails ADP (actual deferral percentage) or ACP (actual

contribution percentage) tests for nondiscrimination

Preparing Ingredients How to Tax Deferred Compensation Plans

Qualified Deferred Compensation• Deferrals

• Subject to social security, Medicare, and FUTA tax• Generally exempt from federal income tax withholding• ROTH contributions taxed at deferral

• Income• Employer not responsible for distributions from plan upon

retirement• Generally subject to federal income tax withholding at time of

distribution (except ROTH funds)


Nonqualified Deferred Compensation• Tastes like…• 457(f) plans• Stock options where exercise price is

below fair market value on the date of grant• Some split-dollar life insurance

arrangements• 409A plans


Nonqualified Deferred Compensation• Found in canned goods section• Employee has rights to compensation that is payable in a

later year• Not subject to nondiscrimination requirements• May be funded or unfunded• Employer responsible for issuing payment for deferred

income


Nonqualified Deferred Compensation• What it’s not:• A qualified 401(a), 401(k), 403(a), 403(b); 457(b); SEP,

SIMPLE, or 501(c)(18) retirement plan• Any bona fide vacation leave, sick leave, compensatory time,

disability pay, or death benefit plan• An Archer MSA, HSA, HRA, or other medical expense

reimbursement plan that satisfied IRC 105 and 106


Nonqualified Deferred Compensation• How to identify spoiled product• Deferred amounts are distributed earlier than restrictions

allow• Employer funds plan for top five officers while other financial

circumstances are insecure

Preparing IngredientsHow to Tax Deferred Compensation Plan Amounts

Nonqualified Deferred Compensation• Taxing deferred amounts• Income tax

• Funded plan contributions subject to income tax when funds are set aside

• Unfunded plan not subject to income tax until payments are issued to employee

• Social security, Medicare, and FUTA tax calculated when amounts are deferred

Preparing IngredientsHow to Tax Deferred Compensation Plan Amounts

Nonqualified Deferred Compensation• Calculating deferrals• Account balance plans• Nonaccount balance plans• Stock rights• Other deferred amounts

Preparing Ingredients How to Tax Deferred Compensation Plan Amounts

Nonqualified Deferred Compensation• Taxing income amounts• To calculate income tax withholdings,

treat amounts required to be included in income as supplemental wages• Income from nonqualified deferred

compensation is not subject to social security, Medicare, and FUTA tax, as this was calculated at the time of deferral


Nonqualified Deferred Compensation

• When to withhold and pay taxes on includible income• Amounts actually paid to employee during the year

• Considered wages paid on the date received by the employee• Tax deposits and returns are due accordingly


Nonqualified Deferred Compensation

• When to withhold and pay taxes on includible income• Amounts not actually or constructively paid during the year

• Considered wages paid on December 31• Tax deposits must be paid by the due date of 4th quarter Form 941

Preparing Ingredients How to Report Deferred Compensation Plan Amounts

Nonqualified Deferred Compensation• Reporting Deferrals

• Income tax reporting• Unfunded plan deferrals (employer contributions) not reported on Form 941,

W-2, or 1099-MISC• Funded plan deferrals generally reported in Box 1 of Form W-2 and in Box

11 as taxable income from a nonqualified plan• Social security, Medicare, and FUTA tax reporting

• When “taken into account,” deferred amounts are reported in Box 3 and 5 of Form W-2

• If any deferred amounts taken into account are from prior years, also report in Box 11 of Form W-2


Nonqualified Deferred Compensation• Reporting Distributions from Plan

• Social security, Medicare, and FUTA tax• Not subject to tax at distribution

• Income tax• Report amounts not taxed at time of deferral on Line 2 of Form 941 and in

Box 1 of Form W-2• Report amounts currently includible in gross income from all years’ deferrals

(plus earnings on those amounts) in Box 12 of Form W-2 with Code Z

• Report amounts includible in gross income for independent contractors in Boxes 7 and 15b of Form 1099-MISC


Nonqualified Deferred Compensation• Form SSA-131, Employer Report of Special Wage Payments

• Used to report total amount employee earned during the tax year• Normally the amount in Box 1 of Form W-2 less payments from a

nonqualified plan, but including amounts deferred under the plan during the year

• Do not file if contributions and distributions occur in the same year and the employee will not be age 62 or older by the end of that year

Selecting Ingredients Varieties of Stocks and Stock Options Plans

Employee Stock Ownership Plans• Tastes like…• Stock bonus plan• Combined stock bonus and money purchase plan


Employee Stock Ownership Plans• Must meet general requirements under IRC §401(a)

for participation, vesting, nondiscrimination, etc.• Two types of funding:• Nonleveraged – plan buys stock with funds provided by

employer• Leveraged – plan buys stock with borrowed funds

Preparing Ingredients How to Tax Stocks and Stock Options Plans

Employee Stock Ownership Plans• Employer contributions to qualified ESOP • Are not wages• Are not subject to federal income tax withholding or social

security, Medicare, or FUTA tax• May not exceed 100% of employee’s annual compensation

and no more than $52,000


Employer Stock as Compensation• Tastes like…• Compensation for services

rendered• Compensation in the form of stock

as opposed to cash wages


Employer Stock as Compensation• Fair market value of stock when transferred to

employee is subject to federal income tax and social security, Medicare, and FUTA tax• Example:

Employee is paid $500 regular wages and $500 in stock

Federal income tax withholding and social security, Medicare, and FUTA tax are calculated on $1,000 and withheld from regular wages.


Employer Stock as Compensation• When stock is no longer subject to substantial risk of forfeiture,

value above amount already taxed is included in recipient’s gross income

• Substantial risk of forfeiture is defined as a contingency that exists on the receipt of future compensation, which could prevent the transfer of said compensationFair market value when transferred to

employee

Amount paid for stock by employerCompensation subject to tax for recipient


Statutory Stock Options• Tastes like…• Incentive stock options (ISO)• Employee stock purchase plans (ESPP)


Statutory Stock Options• Terminology• Grant date is the date on which an employee receives a stock

option• Exercise date is the date the stock will be purchased• Option date is the date payment is made to secure the

purchase of stock• The value of the stock on each of these dates is pertinent


Statutory Stock Options• Incentive stock options• Employees have opportunity to buy employer corporation’s

stock at a fixed price for a certain period of time• Not subject to income tax withholding and no income

recognized until stock is sold if conditions are met


Statutory Stock Options• Employee stock purchase plans• Employees have opportunity to buy employer corporation’s

stock at a discount• Not subject to rules as strict as ISOs


Statutory Stock Options• No employment taxes upon exercise or sale• Not considered wages because post tax dollars used to

purchase – no different than purchasing stock from a broker• No W-2 reporting required


Statutory Stock Options• Report stock option activity when corporation transfers

legal title to stock• ISO activity reported on Form 3921, Exercise of an Incentive

Stock Option Under Section 422(b)• ESPP activity reported on Form 3922, Transfer of Stock

Acquired Through and Employee Stock Purchase Plan Under Section 423(c)

• Taxed at capital gain rate when stock is sold


Nonstatutory Stock Options• Tastes like…• Option for employee to buy employer corporation’s stock at a

fixed price for a certain period of time, without conditions placed on ISOs• Taxable income = Value of stock when option exercised –

price paid by the employee


Nonstatutory Stock Options• Income subject to federal income tax withholding and

social security, Medicare, and FUTA taxes at time of exercise • Report in Boxes 1, 3, and 5 of Form W-2 and include in

Box 12 preceded by Code V

Selecting Ingredients Varieties of Executive Pay and Perks

Executive Pay and Perks• Tastes like…

• Golden parachute pay• Club dues• Personal Use of Co Vehicle• Personal use of Co Aircraft• Restricted Stock• Severance Agreement• Financial Counseling• Spouse Travel• GTL over $50

Preparing Ingredients How to Tax Executive Pay and Perks

Executive Pay and Perks• Golden parachute pay• Issued to key executives when company ownership changes• Used to “soften landing” if employment is terminated under

new ownership• Payment is at least three times employee’s average annual

compensation over last five years


Executive Pay and Perks• Golden parachute pay• Entire payment subject to federal income tax withholding and

social security, Medicare, and FUTA tax on entire amount• Portion of payment in excess of employee’s five-year average

subject to additional 20% excise tax• Report excise tax in Box 12 of Form W-2, preceded by Code K


Executive Pay and Perks• Club dues• Not taxed if substantiated for business use• No reporting required

Selecting Ingredients Varieties of Executive Pay and Perks

Executive Pay and Perks• Miscellaneous executive perks treated same for

executives as non-executives:• Personal Use of Co Vehicle• Personal use of Co Aircraft• Restricted Stock• Severance Agreement• Financial Counseling• Spouse Travel• GTL over $50

Still have questions?Feel free to send us an email at

[email protected] or [email protected].

Thank You for Attending!

21st Annual IL Statewide APA Conference – August 21-22, 2014

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21 st Annual IL Statewide APA Conference

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