A CREDO TAX PLANNING STRATEGY SOLUTION
This whitepaper serves as your helpful guide to understanding the most common types of executive compensation, how they work, and the income tax repercussions that executives should consider to optimize both their executive compensation and overall wealth. We will show you how our team at Credo can help you in navigating the complexity of executive compensation packages using proper tax planning and strategy allowing you to pay as little tax as possible and get the most out of the awards you’ve worked so hard to earn.
As an executive, you are primed for great financial success that’s why you are eager to learn about planning techniques that will allow you to structure your compensation and benefits packages to be partially non-taxable or tax-deferred.
It’s important to keep as many funds in your pocket as possible. Executive remuneration packages are complex and diversified, requiring a high level of expertise and sophisticated wealth planning techniques.
At Credo, we don’t want to show you how to invest your money, but we’ll help you keep funds in your pocket to provide flexibility for you and your family’s future through:
– Starting the long term capital gain clock early
– Deferring gains and control when you recognize the gain
– Consulting with a tax strategist on your stock purchase program
– Applying strategies towards your base salary and
– Our tax strategist can navigate you to an optimal return, saving you up to $200k!
Then, we can help you strategize what you’ll do with those savings. Are you charitably inclined? Interested in real estate? Grow your finances through brokerage account? Estate planning? You can help do those things, while simultaneously saving on your taxes!
STOCK-BASED COMPENSATION PROGRAMS
There are numerous forms of equity, not all of which are treated equally by the IRS. Understanding precisely what one possesses is essential to unlocking the full potential worth. Equity-oriented plans base compensation on the value of the company’s stock and can include cash, stock, or options to buy stock. For each category, there are different types of plans, and the way the executive is taxed depends on how they are paid and what choices they can make.
There are three powerful methods that we can use as tax planning strategies:
This can be utilized to reduce or eliminate taxation upon the vesting of a stock award or existing stock option. Additionally, it can be used to defer the recognition of income from RSU shares or options for five years after vesting.
Creating a donor-advised charitable fund enables an individual to donate a percentage of equity or cash in advance, earn a tax deduction in the same year, and then donate the funds over a period of years.
A Conservation Easement is eligible for a charitable income tax deduction under the Internal Revenue Code. To qualify for the deduction, the easement must be “granted in perpetuity” to a qualifying organization for the exclusive purpose of conservation.
RESTRICTED STOCK (RSUs)
A restricted stock unit (RSU) is an employer’s unfunded pledge to transfer shares in the future. The majority of RSU programs stipulate that the employee will not receive actual shares of stock until all vesting requirements have been satisfied.
RSUs are taxable as income upon vesting. There is no direct method to decrease or defer this tax. However, with little forethought, you can utilize your RSUs to offset other income (thus reducing your total tax liability) or to defer capital gains taxes.
It is feasible to make an 83(b) election to lessen the potential tax burden of restricted shares. This option permits you to pay income tax on your restricted stock shares upon receipt, rather than annually as they vest. If the value of the stock at the time of the award is significantly less than when it vests, a Section 83(b) election can result in large tax savings.
EMPLOYEE STOCK PURCHASE PLANS (ESPPs)
Employee stock purchase plans (ESPPs) are plans that allow employees to purchase shares of the employer’s stock at a discount. Employees do not pay federal income tax on the discount when the option to purchase is provided or exercised if the ESPP meets the requirements of IRC Sec. 423.
ESPPs can have multiple stock offerings. Offerings can be consecutive or overlapping, and their terms do not have to be identical as long as the terms of the plan and the offering meet the requirements.
ESPP shares can function as a turbo-charged savings account that you can use to advance your financial goals because of the discounted acquisition price. Some options to do that are: increasing your cash flow, funding short-term objectives, boosting your long-term savings, investing your ESPP shares in a brokerage account, indicating the level of company shares you wish to own, and automating your strategy.
COMPONENTS OF EXECUTIVE COMPENSATION
The right to purchase shares of the company’s stock at a predetermined exercise strike price is granted to the option holder under ISO awards. They normally have a 10-year window in which they must be exercised or they will expire, and they could be subject to vesting restrictions. Although there may be an AMT tax preference item equal to the fair market value (FMV) of the stock that day over the exercise strike price, there is no regular taxable income when options are exercised. If the taxpayer keeps the shares of stock for more than one year following the date of exercise and two years following the date of grant, they will be treated as long-term capital gains when they sell the stock. If sold sooner, the income will be subject to ordinary income tax rather than long-term capital gains, as well as a 3.8% net investment income tax. Additionally, an incentive stock option is considered as a nonstatutory option to the extent that the total fair market value of the stock that an individual may exercise for the first time under an incentive stock option during any taxable year exceeds $100,000. The option changes to a non-qualified stock option if the conditions of an ISO are not satisfied.
NQSOs are comparable to ISOs in a way that they give the option holder the right to buy shares of the company’s stock at a predetermined exercise strike price. Rights normally have a 10-year window in which they must be exercised or they will expire, and they may be subject to vesting restrictions as well. The key distinction is that when they are exercised, compensation income is generated that is subject to ordinary income tax rates that can reach as high as 37%, in addition to FICA and FUTA taxes (FICA, or the Federal Insurance Contributions Act, funds Social Security and Medicare; FUTA, or the Federal Unemployment Tax Act, funds unemployment benefits). The difference between the FMV at the date of exercise and the exercise strike price is the amount of taxable income. The holding period of the stock therefore starts on the day following the exercise date, and the stock received then assumes a basis equal to the FMV at that time.
Another type of restricted stock award is performance shares, although these awards are subject to the company’s success, such as its overall earnings or the profits of the specific division where the grantee executive works. In this situation, the final reward at the time the shares vest could be nothing or greater than the initial grant. A common range may be 0% to 200%.
These plans enable the executive to postpone a portion of their present income and any revenue made thereon until one or more predetermined future dates. Additionally, these programs are governed by complex regulations, which an executive should discuss with their tax expert. For instance, choosing a payout term is one of the most crucial factors for an executive to think about because the payout cannot be changed without negative effects. The timing of the payout, which is set at the employee’s choice, can be either spread out over time or as one lump sum. These plans are subject to the creditors of the firm and are not shielded if the company goes bankrupt. The payouts are subject to standard tax rates when paid. When setting them up, state income taxes should also be taken into account. Moving to a state that doesn’t tax income after deferring revenue earned while residing in one won’t always stop the taxing state from taxing the income. Once more, when establishing these plans and managing these challenges, a tax expert should be consulted.
For employees whose benefits under the employer’s qualified retirement plan are constrained by the application of Internal Revenue Code (IRC) Section 415, an excess benefit plan is a nonqualified deferred compensation (NQDC) plan that offers supplementary retirement income benefits. Simply put, the excess benefit plan’s objective is to enable employees who take part in qualifying plans to go above the restrictions established by Section 415. The benefit offered to an employee under an excess benefit plan typically consists of the difference between the benefit they would have gotten under the employer’s eligible retirement plan had the Section 415 limitations not been applied and the benefit they actually get under the plan.
By connecting an employee’s long-term rewards to the long-term results of the organization, they give incentives for employees to enhance the overall performance of the company (usually two to five years). typically dependent on achieving performance goals and taxed similarly to NQSOs
Top-level employees may be granted access to a package of benefits known as a supplemental executive retirement plan (SERP) in addition to those provided by the company’s ordinary retirement savings plan.
One type of deferred compensation plan is a SERP. It does not qualify as a plan. That is, neither the employer nor the employee receives a preferential tax treatment similar to that offered by a 401(k) plan.