EXECUTIVE BENEFIT CHECKLIST

1. Nonqualifed Deferred-Compensation or Supplemental Retirement Plans. A nonqualified deferred-compensation plan provides additional retirement or deferred-compensation benefits to key employees in addition to, or in place of, the amounts received under the employer's qualified plan, if any. There is a great deal of flexibility in the design of such plans, and many approaches have been used. (See later discussion.)

2. Restricted Stock or Other Property. Restricted property plans provide compensation to executives in the form of property, usually stock of the employer company, that is restricted in such a way as to help retain the services of the executives or provide an incentive for good executive performance. (See later discussion.)

3. Stock Options. Stock option plans are used for purposes similar to restricted stock plans; however, with an option plan, the employee is given an option to buy the stock at a stated price rather than an outright grant of the stock subject to restrictions. (See later discussion.)

4. Life Insurance. Life insurance is a valuable benefit for key employees. As discussed later, it can be provided in a variety of ways.

5. Severance Pay. Most employers have some form of severance pay policy for employees, often at a minimal level for rank-and-file employees. Executives, however, often negotiate favorable severance pay provisions as part of their compensation package. One particular type of contract regarded by Congress as abusive is the "golden parachute" contract, under which a company agrees to pay an executive large amounts of severance pay if the company changes ownership. Under Code Section 280G, tax deductions for golden parachute payments can be denied to the employer if the amount is excessive-generally, if it is at least three times the executive's average annual salary.

6. Cash Bonus and Incentive Plans. Executive compensation plans often include plans for cash bonuses paid currently or deferred for a relatively short period of time that are tied to company or executive performance. Most of these programs are based in some manner on growth in company earnings during the executive's tenure in office. Often the bonus or incentive award depends on the attainment of specified target earnings objectives. There are many design considerations for such plans, including eligibility for the plan, the amount of the award and the benefit formula, and the period of time over which executive performance will be assessed. All these design features must be tailored to the employer's specific situation. There are no special tax complications for these plans; generally, the compensation is taxable to the executive when received and deductible to the employer at the same time.

7. Additional Medical Expense Benefits. Additional health insurance is an attractive executive benefit, particularly where the company's basic plan has gaps in coverage.

8. Disability Income Plans. As with health insurance, the company may wish to provide a disability income (salary continuation) plan for executive employees to cover any gaps in or to supplement the company's broad-based disability income plan. If the additional coverage is provided through insurance owned by the company, the premium is fully deductible to the employer but benefits are taxable to the employee when paid, subject to a disability income tax credit that disappears for higher income employees. If instead of relying on a company-provided plan, the executive purchases his or her own disability income insurance, the premium payments by the employee are nondeductible, but disability income payments are nontaxable. Because of this, many companies may prefer simply to provide extra compensation income to executives with the understanding that the executive will have the option of obtaining personally owned disability income insurance coverage.

9. Loans to Executives. A plan providing loans from company funds to executives on favorable terms may be attractive to executives. If the executives are owners of the company, such a program also provides a means of withdrawing corporate funds on a favorable basis, that is, without being taxed on the receipt of a dividend. While interest-free and bargain loans were once used for this purpose, Code Section 7872 now prescribes a minimum interest rate for such loans, which is basically the interest rate applicable during the same period for federal marketable securities of similar term. If the employee loan has a lower interest rate, the bargain element is taxed as if the employee had received that amount as cash compensation. The purpose of this Code provision is to treat as nearly as possible a bargain-rate loan as if it is a market-rate loan, in order to discourage bargain-rate loans.

   Any employee loan should be a bona fide loan and should be evidenced by a formal written note with a fixed maturity date or a repayment schedule. The employee could be required to provide security for the loan, such as a home mortgage. Loan plans can be relatively unrestricted or can restrict executive loans to specific purposes, such as the purchase of a home or children's educational expenses.

   Interest on the loan will generally be consumer interest that is nondeductible to the employee unless secured by a home mortgage. Interest could also be deductible as investment interest if the loan proceeds are used for investments.

10. Other Fringe Benefits. An infinite variety of perquisites and fringe benefits for executives is possible; for example, executive dining rooms, favorable expense account provisions, financial counseling and estate planning for executives, additional moving expense reimbursements, payment of professional association dues, and trips to professional seminars. The usefulness of these benefits depends entirely on individual facts and circumstances.

    The decision whether to provide any of these benefits is often affected by their federal income tax treatment because executives tend to be in high marginal income tax brackets and prefer to receive extra compensation in tax-free form.

SIMPLIFIED EMPLOYEE PENSIONS

The simplified employee pension (SEP) is an expanded version of the employer-sponsored IRA, designed by Congress to make it easy and attractive for employers to adopt a retirement plan which, although not a qualified plan as such, has similar features. A SEP is designed much like an employer-sponsored IRA, but the deduction limits are much higher-instead of a $2,000 annual deduction limit, the limit on deductible contributions for each employee is the lesser of $30,000 or 15 percent of the employee's compensation. The price for this expanded deduction limit is that the employer loses discretion as to who must be covered; there is a coverage requirement that in some ways is more stringent than that for regular qualified plans.

Eligibility and Coverage

If the employer has a SEP plan, it must cover all employees who are at least 21 years of age and who have worked for the employer during three out of the preceding five calendar years. Part-time employment counts in determining this; there is no 1,000-hour definition of a year of service. However, contributions need not be made on behalf of employees whose compensation for the calendar year was less than $300 (as indexed for inflation; 2000: $450). The plan can exclude employees who are members of collective bargaining units if retirement benefits have been the subject of good-faith bargaining, and it can also exclude nonresident aliens. Employer contributions to a SEP can be made for employees over age 70½; these employees are not eligible for regular IRAs, as discussed earlier.

Contributions and Deductions

An employer need not contribute any particular amount to a SEP in a given year or even make any contribution at all. In this respect, a SEP is more flexible than any type of qualified plan, even a profit-sharing plan, which requires substantial and recurring employer contributions. However, any employer contribution that is made must be allocated to employees under a definite written formula. The formula may not discriminate in favor of highly compensated employees. In general, the formula must provide allocations as a uniform percentage of total compensation of each employee, taking only the first $150,000 (as indexed for inflation; 2000: $170,000) of compensation into account. The SEP allocation formula can be integrated with Social Security under the usual integration rules for qualified defined-contribution plans.

Each individual in a SEP maintains an IRA and employer contributions to the SEP are channeled to each employee's IRA. For tax purposes, the employer contributions are treated as if they are paid to the employee in cash and included in income and then contributed to the IRA. The Code provides a deduction to both the employer and to the employee for these amounts.

If the employer maintaining a SEP also has a regular qualified plan, contributions to the SEP may reduce the amount that can be deducted for contributions to the regular plan.

Other Requirements

Except for the contribution, allocation, and deduction provisions, the IRAs maintained as part of a SEP are the same as other IRAs and the rules discussed in the previous section apply to them as well. For example, the rules for taxation of distributions from SEP-IRAs are the same as those for other IRAs. As with regular IRAs, loans to participants from SEP-IRAs are not permitted.

Labor and IRS regulations contain certain reporting and disclosure provisions for SEPs. These are simplified if the employer uses the IRS prototype SEP contained on Form 5305-SEP. This form was designed to simplify the adoption of SEPs by employers; however, it uses a nonintegrated formula.

When Should an Employer Use a SEP?

The term simplified in the name of these plans is somewhat misleading; a SEP is not really much simpler than a regular qualified profit-sharing plan, especially where a qualified master or prototype plan is used. However, installation costs are minimal where the government Form 5305-SEP is used; administration costs are low because the annual report form (5500 series) need not be filed. Thus, SEPs are attractive for cases where administrative costs must be absolutely minimized, such as a one-person plan. In other specific situations, the special coverage rules for SEPs may be more attractive than the regular coverage rules. From an employee viewpoint, the complete portability of the SEP benefit is attractive.