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.
CEOs and executive teams of today lead more than a company. They oversee a complex array of employees, partners, and investors with a stronger emphasis on communities and the environment. As an executive, you deserve to be offered an executive compensation package that is fair, simple, clear and trusted. The salary package that you receive is more intricate than that of the other employees’. You normally receive a higher level of income and perks in line with your greatly increased responsibility and accountability for overall company performance as well as to internal and external stakeholders.
The strategic objectives of the organization, its capacity to draw and keep talent, its ownership structure, culture, corporate governance, and cash flow are all important driving elements for the plan’s various components, all of which should be in line with the performance of the company.
Executive compensation is a comprehensive remuneration package provided to executives to enhance both their personal and the organization’s performance. Salary, fringe benefits, and bonuses are just a few of the different ways that compensation may be given. You might receive stock-based pay, such as stock options, restricted stock, or restricted stock units (RSUs), if you’re an executive or other key employee (either incentive or nonqualified). Your executive compensation package may also include nonqualified deferred compensation (NQDC). These forms of remuneration can have complicated tax effects because they are subject to payroll, capital gains, ordinary income, and other taxes. Therefore, wise tax planning is essential.
COMPONENTS OF EXECUTIVE COMPENSATION
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.
When an employer grants restricted stock to an employee, the employee’s access to the shares is restricted until the shares vest and the restrictions are lifted. Stock that is restricted typically has a high risk of forfeiture. When the restricted stock is granted, there is no tax consequence; but, when the stock vests and/or the restrictions end, the taxpayer normally recognizes ordinary compensation income equal to the difference between the FMV and any possible stock purchase price. The stock’s holding period therefore starts on the day of vesting or the expiry of restrictions, and any future gain will be considered long-term capital gain if the shares is kept for more than a year after that date.
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.
These are corporate-run programs that give employees the opportunity to acquire up to $25,000 worth of company stock each calendar year at a reduced rate that occasionally reaches 15%. Payroll deductions from the employee’s paycheck are used to fund the plan, and at predetermined intervals, the plan buys business shares. To qualify for the advantageous long-term capital gains treatment, shares must be held for more than two years following the start of the offering period and for more than one year following the acquisition date.
TAX REDUCTION STRATEGIES FOR HIGH-INCOME EARNERS
You’ll be relieved to learn that there are numerous tax-reduction techniques available for high-income workers if you’re in a high tax bracket. To pursue them, though, you must be tenacious enough, or you must seek the assistance of an excellent tax strategist like Credo. High-income earners and wealthy individuals may find it challenging to keep up with the most recent tax planning techniques due to the regular changes in tax regulations and growing complexity.
Along with the responsibility of managing a business comes the complexity of long-term wealth planning brought on by an executive compensation plan. Equity-based remuneration, which can be a very effective means of wealth generation, is one of the greatest advantages accessible to you as an executive. However, each component of your remuneration package necessitates highly personalized wealth planning care. Spend some time learning about the many different qualities of these offerings so you can develop smart plans.