How Big Does Your ROI Have to Be? You Can Get It Here

Let's make believe it's 2018. Let's further make believe that the Tax Cuts and Jobs Act (TCJA) or whatever it's long-winded name turned out to be was signed into law late last year. And, let's finally make believe that you hold a corporate position where you get to weigh in on corporate investments and deployment of capital.

Just how big of a return on investment do you need to be able to project in order to pull the trigger?

8%? 10%? 12%? 15%?

For most of you, I'm guessing that I've finally surpassed or at least hit your target. You'll definitely want to read on. For those that need a bigger number, give me a chance. But, I didn't want to scare away those people who think that really big numbers are only found in Fantasyland.

For those of you that really want to get into the technical details, I'm going to refer you to an excellent piece written by my Partner, Brian Donohue. Some of you may not want to get into that level of gory detail and you just want the big picture and a summary to convince you, you've come to the right place.

First off, you need to sponsor a defined benefit (DB) pension plan. It's fine if it's of the cash balance or some other hybrid variety. So, let's suppose that you do because if you don't and you have no plans to, unless you just really love my writing or just have a strange desire to find out what you are missing out on, you can probably stop reading now.

I don't want to put this in terms of dollars because if I talk about billions and you are a $100 million company, you may not think this is for you. And, conversely, if I talk about millions and you think millions go away in rounding, you won't think it's for you. So, let's talk about units.

Suppose your DB plan is fully funded on a Schedule SB basis. In other words, your funding target and your actuarial value of assets both equal 1000. Then your minimum required contribution, generally speaking, is equal to your target normal cost, probably not a big number compared to what we are talking about here.

Despite not having to, contribute 200 units. Go ahead. Do it. Trust me. I wouldn't sell you snake oil.

Here are your benefits from having done so before September 15, 2018 (assuming calendar year plan year and tax year):

• The 200 units are tax-deductible under Code Section 404 for 2017 when your corporate marginal tax rate was likely 35% (yes, there are unusual circumstances where they may not be or where the deductions may not be of value to you, but for most sponsors, this is the case) as compared to 21% beginning in 2018. Savings of 14% of 200=28 units.
• Your PBGC variable rate premiums may come down by as much as 8 units, But that could be as much as 8 units per year for multiple years (let's call it 5 years for sake of argument). Savings of 8 units times 5 years=40 units.

That's 68 units of savings on a 200 unit deployment of cash. That's 34%.

Now, I'm not going to claim that your ROI here is actually 34%. Yes, you will contribute these amounts more than likely in future years and when you do, you will take a tax deduction. But, you'll take it in the future (you remember time value of money) and you'll only get a 21% deduction when you do. And, yes, you may not get those full PBGC savings and some of them will be in the future, but your savings are likely to be significant.

And, then there is the other really key benefit -- your plan will now have a surplus on a funding basis meaning that you almost certainly don't have to contribute and deal with volatility of minimum required contributions in the near future.

I'd be doing you a disservice, of course, if I didn't give fair consideration to the downsides and perceived downsides of this strategy. So, I'm going to shoot straight with you.

Yes, you will have 200 units of cash tied up with no immediate means of accessing it. However, it's getting you a pretty good and rapid ROI, so in most cases, I think you'll get over that one.

Pension surplus is considered to be a bad thing. In fact, prevailing wisdom is that pension surplus is worth only pennies on the dollar. Well, sometimes prevailing wisdom shouldn't prevail.

If your DB plan is ongoing, this is just advance funding, plain and simple. It's money that you would have to contribute and the future when you could take your deductions at a 21% marginal tax rate.

If your DB plan is frozen, the argument is a little trickier. But, for most sponsors, if you do have a frozen plan, the cost to terminate is likely going to exceed your funding target. In fact, it's likely to exceed your funding target by a fair amount. So, those 200 units will be put to use.

But, let's take the extreme scenario where your investments do well, interest rates rise, and those 200 units really start to look like trapped surplus. 

Do you sponsor a defined contribution (DC) plan? It may not fit your current DC strategy, but generally speaking, your DB surplus upon termination can be used to fund a "qualified replacement plan" (think profit sharing or non-elective contributions) for up to seven years. So, in that case, you would be getting an advance deduction for future DC contributions.

Convinced this is worth looking into?

Yes, I've simplified things and there are potential tax and legal issues here, so I leave you with this:

Nothing in here should be construed as tax or legal advice which can only be obtained from a qualified tax or legal professional. If you need tax or legal advice, you should consult such a professional. And as with any strategy of this sort, your mileage may vary.

Tax on CEO Pay Ratios That Are Too High

Back in 2010, stuck in Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act, corporate America was blessed with a new requirement -- disclose the ratio of the annual total compensation of the CEO to that of the median-paid employee in the company. It seemed simple enough except that it's not. Here are some reasons:

• Annual total compensation isn't what you think. It's compensation as defined for proxy purposes (Form DEF 14A) and it includes things like increases in value and retirement benefits as well as the value of certain stock compensation.
• The median-compensated employee is the one who is compensated such that half the people in the company are better paid and the other half are not paid as well. So, to determine the median-compensated employee, you have to determine that half the company is paid higher and half is paid lower. (Yes, we can make some simplifying assumptions, but it's still not as simple as just picking a person.)
• Foreign-domiciled employees count and we have to convert currency.
• Part-timers and seasonal employees count and we are not allowed to annualize their pay.

All of this is so that a company can disclose a single number in its definitive proxy statement -- the ratio of pay of the CEO to that of the median employee.

And, then the pain ends, right?

Wrong!

People will see this number. Shareholders will see it, unions whose members the companies employ will see it, institutional investors will see it, shareholder advisory services will see it, and cities and states will see it.

Cities and states you say? Why would these issuers of proxies care about that?

Frankly, for most companies, the financial effects imposed by cities and states will be more of a nuisance than anything else, but Portland, Oregon led the way by imposing a surtax on companies doing business there if there pay ratio is too high. The business tax in Portland, generally, is 2.2% of income derived from Portland business. But, the following surtaxes will apply:

• If a company's pay ratio is at least 100 to 1, but less than 250 to 1, there will be a 10% additional surtax;
• If a company's pay ratio is at least 250 to 1, there will be a 25% additional surtax.

Other cities and several states have proposed similar laws and while some may have passed, I personally am not aware.

As I said, these taxes are not a big deal in the scope of the companies involved, at least not for the most part. At the same time, however, I think we are going to see that companies with pay ratios exceeding 100 are going to be quite common.

To the best of my knowledge, taxes of this sort were first proposed by former Labor Secretary Robert Reich in 2014. Secretary Reich points out that pay ratios in the early 70s averaged about 28, but we should note that statistic as being based almost entirely on full-time American workers. The labor force has changed. And, so has the pay ratio. 

Is Your Executive Plan Top-Hat?

Most larger companies and some smaller ones provide many of their higher paid employees the opportunity to participate in a nonqualified retirement plan often referred to as a Supplemental Executive Retirement Plan or SERP. The rationale for having such a plan is spelled out in ERISA. The regulations specifically grants "top-hat" status to plans that are limited to a select group of management or highly compensated employees. The plan must also be unfunded (and for those people who say that lots of top-hat plans have assets set aside, that is informal funding in a rabbi trust or through insurance products or some other means).

Before going further, I'd be remiss if I did not mention that my motivation for posting this is a recent series on top-hat plan litigation in Mike Melbinger's blog.

So why should an employer or employee care if their plan is a top-hat plan or not? According to regulations under ERISA Section 104, top-hat plans are exempt from the participation, funding, vesting, and fiduciary rules under ERISA. As we shall see, this can be critically important, especially in the current statutory environment.

Backpedaling just a bit because this will help the less knowledgeable reader to understand why top-hat plans exist, let's consider what it could mean to be in a top-hat group. ERISA was enacted in 1974 to provide certain protections for employees in retirement and certain welfare benefit plans. When a plan is exempt from some of the key provisions of ERISA, it fails to provide those protections. So, being in a top-hat plan could alert a participant that he or she might not need those protections.

As some authors, mostly attorneys, have pointed out, the last year or two has seen more than the usual amount of litigation related to top-hat plans. In the typical situation, either an individual thinks that they were improperly excluded from a top-hat plan (in my completely non-legal view, this would be a tough claim to make) or because they were in a plan that was treated by their employer as being a top-hat plan, but they thought that it did not satisfy the criteria for being top-hat.

Depending on your viewpoint, the latter is either an easy claim or a difficult claim to make. Why is that? It's been more than 40 years since the passage of ERISA and we still don't have formal DOL guidance telling us what a top-hat group is. Some have argued that an individual may properly be in a top-hat group by being either management or highly compensated or both. Despite the current definition of highly compensated (Internal Revenue Code Section 414(q)) not existing until late 1986, some have argued that satisfying that criterion is sufficient. Many years ago, the DOL floated a concept that a person should be eligible for a top-hat group that a person would be eligible if their compensation was at least two times (three times in a separate informally floated concept) the Social Security Wage Base. And, finally, there is the concept that a person may rightfully be in a top-hat group if by the nature of their position, they have the ability to influence the design and amount of their compensation and benefits package.

So, knowing that we currently don't know what a top-hat group actually is, why do we care?

Suppose your company sponsors what it believes to be a top-hat plan and it turns out that it's not top-hat. Then, it's going to be subject to some fairly onerous provisions that could create massive current costs in some cases and unsolvable compliance issues in others.

Consider the following scenario.

Suppose you have a DB SERP with 20 participants. Further suppose that for whatever reason, this plan is found to not be a top-hat plan. Assuming that the company is large enough, then the plan will fail the minimum participation rules and it will necessarily (unless the company has only highly compensated employees) fail the minimum coverage tests. Full vesting must occur generally within 5 years of entry and that entry must occur not later than age 21 with 1 year of service. The plan must be funded according to ERISA's minimum funding rules. And, those plan assets must be invested according to ERISA's fiduciary standards. But, the plan will still not be a qualified plan as it doesn't meet all of the Internal Revenue Code's standards under Section 401(a).

If the plan is not qualified, it must be a nonqualified plan of deferred compensation. That makes the plan subject to Code Section 409A. So, let's throw in one more wrinkle. Let's suppose the company also sponsors a qualified DB plan and let's suppose that the qualified plan is less than 80% funded. Now, you are between a rock and a hard place. Setting aside assets (funding) for the nonqualified plan will violate Code Section 409A which will subject participants to a very large unplanned additional tax liability. (By the way, those participant will likely have to find a way to pay those taxes perhaps without having access to the deferred compensation assets in order to pay them.) Not funding the SERP will cause the plan to fail to meet minimum funding standards which will result in excise taxes under IRC 4971.

Ouch!

What should an employer do?

I've been told by more than one attorney that it is unlikely that you can get a formal legal opinion that your top-hat group is, in fact, a bona fide top hat group.

If you can't get a formal legal opinion, perhaps the best way to get comfort is to get an outsider with expertise in this area to assist with an independent analysis.

Looking at a history of case law and DOL opinion on the topic, one might consider these elements:

• The percentage of the workforce in the top-hat group
• The relative pay of the top-hat group as compared to the pay of those people not in the top-hat group
• Whether the top-hat group was selected by the Board as compared to being, for example, any employee with the title Vice President or higher
• Whether individuals in the top-hat group, especially those among the lower-paid in the group, have significant management responsibilities
• Whether individuals in the group need the protection of ERISA

Nobody really knows. But, having an independent analysis might show that an employer is acting in good faith in determining the group. Given the downside of getting it wrong, it may just be worth it to find out.

Finally, I want to reiterate that I am not an attorney and I have no qualifications to provide legal advice. As such, nothing in this post or anything else that I write should be construed as legal advice or as the practice of law.

Is IRS Stepping Up Nonqualified Audits?

Two weeks ago, the IRS released nonqualified deferred compensation audit techniques guide. While no one can be certain, this would seem to signal that the Service is showing more interest in auditing these plans, available almost exclusively to the highest paid of employees.

For years, many have thought that nonqualified (NQDC or NQ) plans to be a significant area of tax abuse and a potential source of tax revenue for the federal government. And, whether this is simply a much needed update or the beginning of a push, the language in the guide would seem to suggest where the IRS thinks there are problems.

Let's look at the paragraph headers in the guide as a means of determining where the focus is likely to be:

1. Examining Constructive Receipt and Economic Benefit Issues
2. Audit Techniques
3. Examining the Employer's Deduction
4. Employment Taxes
5. Important Note [related to 401(k) plans]
6. The American Jobs Creation Act of 2004 [the law that brought us Code Section 409A]

Constructive Receipt and Economic Benefit Issues

Here, the guide instructs auditors to look for assets set aside free from creditors for the benefit of employees. It also instructs these auditors to look to see how executives can use the benefits in these nonqualified plans. For example, if a SERP might be pledged as collateral, then the employee has enough control to have constructively received the benefit and is subject to current taxation, or was when the benefit was first constructively received. 

For employers with any knowledge of NQDC plans or those who use counsel who work at all in this area, getting this right falls under the heading of basic blocking and tackling. So, while the IRS might be able to find some defects here, it would not seem to be a source of significant revenue.

Audit Techniques

In this section, frankly, I think that the IRS is grasping at straws. It asks auditors to interview personnel most knowledgeable about the plans. Further, the auditors are encouraged to review Forms 10-K and to learn whether the company uses a consulting firm to assist with its NQDC plans. 

There seems to be little glue holding this section together. Instead, what I am seeing is that their may be a needle in a haystack and a fortunate auditor might find that needle. Other sections of the guide may prove more fruitful.

Examining the Employer's Deduction

Generally, the amount and timing of the employer's deduction must match the amount and timing of the executive's inclusion in income. Looking from the outside in, this would seem to be simple. But, corporate tax returns, especially for large corporations are quite complex. Similarly, a corporate executive is fairly likely to have a complex tax return. It's not unlikely that treatment of income from NQDC plans is nowhere near the top of the priority list for either the corporate tax department or for the executive's accountant. 

In fact, in my experience, some corporate tax departments do not have significant familiarity with this type of plan (some have exceptional knowledge). Similarly, and perhaps more glaring, many personal accountants, again in my experience, just don't know much about nonqualified plans. 

The Internal Revenue Code is a complex instrument. The instructions to government forms, especially if you include the various Publications that they reference, are quite confusing. If an accountant deals with particularly few NQDC plans, it would not be shocking to find that accountant confused by their tax treatment. Certainly, I would not expect them to confirm that the amount and timing of inclusion in income coincides with the corporate tax deduction.

Employment Taxes

This is the section that deals with FICA and FUTA taxes. Until the cap was removed from Medicare wages, this section would have been ignored. The reason is that although nonqualified deferred compensation is subject to these taxes when it is both vested and reasonably ascertainable (a technical term meaning that a knowledgeable person can figure out about how much it is worth), virtually all NQDC participants earned far more than the Social Security Wage Base each year. But, when the cap at the Wage Base was removed for Medicare taxes, new NQDC was necessarily subject to that tax. 

The regulations on this topic are, in a word, confusing. Specifically for what are known as non-account balance plans (generally defined benefit SERPs), the guidance on how to perform calculations was likely written by someone who did not know what they were prescribing and the guidance on the actuarial assumptions to be used in those calculations is virtually nonexistent.

However, in my experience with this topic, the IRS does have strong opinion on what the Treasury Regulations mean and intend. That said, when the regulations under Section 3121(v) were issued, I co-authored a research memo on the calculation of the amount of FICA wages from NQDC plans (the focus was on non-account balance plans). To say that the authors went back and forth many times before agreeing on the intended methodology is an understatement. To think that similar authors at other actuarial consulting firms would reach exactly the same conclusion is no plausible. Add to that the various accounting and tax firms who might have their own opinions and you would certainly have a lack of consistency. About 15 years ago, however, one IRS examiner that I spoke with off the record said that there was just one consistent method available under the regulations.

Said differently, while I don't know how much revenue is potentially available, the calculation of employment taxes with respect to NQDC plans, and specifically non-account balance plans would not all meet with the approval of that particular examiner.

Important Note [related to 401(k) plans]

The coordination of qualified 401(k) plans and NQDC plans that provide for deferrals in excess of those allowed in the qualified plan seems like it should be simple. It's not. In particular, it's not if the two plans (qualified and nonqualified) are administered by different providers (or if one is administered externally and the other internally). Generally, these plans allow participants to defer amounts where IRS limits would otherwise preclude such deferrals. In the simple situations where the 401(k) plan passes nondiscrimination testing, this is pretty easy. But, when the plan is forced to refund deferrals due to test failure or when deferrals are restricted in hopes of making the testing work, things can go horribly wrong. Do the two separate administrators communicate with each other? It's doubtful.

There is likely not a lot of revenue for the government to find here, but there are probably a large number of very small problems.

The American Jobs Creation Act of 2004 [the law that added Section 409A to the Internal Revenue Code]

I've written about 409A here many times. If you are interested, go the little search box at the top of the page and type 409A. I'd be surprised if you get fewer than 25 hits in this blog, but I've not counted. 

As is often said about relationships, it's complicated. 

The regulations are long and were written in a fashion similar to the regulations under Section 3121(v). Frankly, I don't think the people who worked on the project did a bad job writing the regulations. They're not perfect, but they wouldn't have been perfect if you or I had written them either, so we must be careful with our criticism.

But, certain parts of the regulations that have lots of calculational elements where the calculations almost necessarily must be performed by actuaries were written by attorneys. I know some of those attorneys. They're smart people. And, they spent lots of time understanding the statute and developing regulations to enforce that statute. They could have done far worse.

The people that I know, however, who worked on the project are not actuaries. While they have some familiarity with actuarial calculations, they don't actually do them and I think they would tell you if you asked candidly that they have only a minimal understanding of them. Yet, for certain types of plans (mostly non-account balance plans), there is much in the way of actuarial calculations that determines potential tax liabilities. 

Frankly, we don't know what was intended. We tend to reference the FICA regulations, but even there as I noted above, the regulations are not prescriptive.

Section 409A is a mess. I don't think anyone intends to violate it, but there are lots of people who don't get it right. Finding the violations is difficult, but if examiners do find violations, with those violations will come some fairly meaningful tax revenue.

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So, that's my take on where the IRS is headed and what value it has to them. Time will tell if I got it right for a change or not.

Frightening Data on DC Plan Ownership

According to an article in this morning's News Dash from Plan Sponsor, fewer families had an individual account retirement plan (defined contribution or IRA) in 2013 than in 2010. However, on the bright side, average account balances have increased over the same period.

What do we learn from this? It's difficult to know for sure, but as is my wont on my blog, I'm going to take a shot at working it out.

Why are average account balances up? Well, the equity markets have performed pretty well over the last few years. Combine that with the fact that there has been time for additional contributions to those accounts and this makes sense. When we combine this, however, with my rationale for the prevalence of accounts decreasing, it may look troubling.

That the number of families with individual account retirement plans is decreasing suggests underlying issues with the economy. What I suspect is that many long-term unemployed or under-employed have had to liquidate accounts that they had a few years ago in order to survive. People laid off from jobs have taken distributions rather than rollovers to live on. I suspect that more often than not, these have been total distributions from smaller accounts. By eliminating some of the smaller account balances, the average and median accounts have grown in size.

That only about 50% of families have individual retirement accounts and only about 65% have any retirement plan at all is not good news for our future economy. How will the remaining 35% live? Moreover, among those 65%, will they have enough to survive in retirement?

The way it looks to me is that for people who are able to fully utilize their 401(k) or other retirement program for their entire working lifetimes, retirement may be comfortable. But this data suggests that this will be a substantial minority. For the rest, the retirement system is failing us.

30 years ago, defined benefit (DB) plans were the bulwark of the corporate retirement system. After years of Congressional meddling, many employers consider DB plans to be impractical. At the same time with further emphasis on individual responsibility, the burden of providing a retirement benefit has been shifted largely to employees.

If you are good at Googling or Binging, you can easily find projections from lots of smart people showing that a good 401(k) plan will be sufficient for responsible employees to retire on. In my opinion, most of these projections are deficient. You just don't see projections that consider leakage including:

• Unemployment for a meaningful period of time
• The necessity to take a job for a short or long time that does not have a savings plan
• Increased cost-shifting of all benefits to the employee which may reduce an employee's ability to save
• High-deductible health plans which force employees in many cases to pay significant amounts out-of-pocket for health care

This data is frightening. The retirement system is severely broken. Too many times, the public policy behind the retirement system has been abused by tax policy. We are left with retirement plans being a toy for Congress to make bills seemingly budget neutral. 

The ability to retire is part of the 21st century American Dream. This data suggests that the retirement part of the dream may be just that -- a dream.

Not pretty ...

Tax Reform on the Horizon ? Probably Not

Representative Dave Camp (R-MI) has just introduced into the House Ways and Means Committee which he happens to chair the Tax Reform Act of 2014. You can read it here. Given that the Republicans only control one house of Congress and do not control the White House, the bill has little likelihood of passing. However, it gives notice as to where the party leadership may want to take tax policy.

After I've done my skim-through of the roughly 1000 pages, I'll try to comment here if it's worthy of any such comment.

When You Know a New Tax is Bad

It seems that every year, there is a new tax that I or someone that I know has to pay or a new tax credit or both. Oftentimes, it can be taken care of on Form 1040 or some form that I already file in one line item, even if it feels like a random number generator fills in the amount that I get to send to my good friends at the Treasury Department.

As all my readers know, the Affordable Care Act (ACA, PPACA, ObamaCare) wasn't just any old law. And, since even the most optimistic of all proponents of the law knew that it would cost a lot of money, new taxes were needed to pay for it. These aren't just any old taxes. I'm talking about two in particular -- the 3.8% Medicare surtax on investment income for those individuals earning over $200,000 and for couples filing jointly earning over $250,000, and the 0.9% additional Medicare tax on earned income in excess of those same thresholds. (By the way, just like perhaps the worst structured tax in history -- the Alternative Minimum Tax -- those thresholds are not indexed.)

I looked at many of the personal taxes in the Internal Revenue Code. Almost without exception, when taxes apply to individuals or to couples filing jointly, the dual threshold is either twice the individual threshold, or at least meaningfully (50% or more) higher.

But, these are not your ordinary taxes.

All you lucky people (maybe you are just hard-working and it's not just luck) who will be subject to these taxes get to fill out not just one new form, but two new forms. That's right, you have to fill out Form 8959 to determine if you (and your employer) paid enough Medicare tax for you [and your spouse]. And, you need to fill out Form 8960 to determine if you were both a lucky earner and a lucky investor for the year.

I'd link you to the forms, but they are only available as drafts right now. And, I'm sure you don't really want to see them anyway.

Suffice it to say that as of now, Form 8960 looks like an easy one, but Form 8959 must have been jointly produced by the makers of Tylenol, Advil, and Aleve. You will have to have your Form W-2(s) in front of you while you suffer through the calculations and the eventual answer. Then if you are really lucky, you get to attach these two forms to your Form 1040 and send more money.

My conclusion? A tax (I know, it's really two taxes, but it looks like one to me) that requires two new forms can't be a good tax. Let's just get rid of it. I want to go back to the original income tax provisions -- pay 1% of your income in excess of $3,000. I'll even accept that the $3,000 is not indexed.

A Service to Go with a Sad Story

I am going to pitch a service here that all employers should consider. If you are spending money to provide additional benefits for your executives, that money should go to them and not to the government.

Sometimes a good idea comes out of a sad story. And, I'm happy to report that in this case, it's sad because a company wasted money providing a generous benefit for its executives and then didn't tell the executives the pitfalls, but it's not sad in the context of someone going bankrupt or suffering a tragedy.

I got a call yesterday afternoon from someone who found me on the internet, probably through this blog. His wife is a participant in a SERP. Her employment with the company ended in July (I don't know how or why, I just know that it ended).

In early 2007, the wife received a communication from her employer. It told her that her SERP was being split into two pieces -- a 409A-grandfathered piece and a non-grandfathered piece. This was a not uncommon strategy. In addition, the non-grandfathered piece had a default payment of a lump sum of the present value of the accrued benefit payable six months after termination. A participant could elect a different form and or timing of payment (within limits defined in the plan). All of this is very normal in the world of SERPs post-409A.

Apparently, that is all the communication told her. It didn't explain the complexities of 409A. From what I could gather, her employer didn't want to give too much information because they were worried about potential litigation. So, they probably figured that giving no guidance at all meant that they gave no incorrect guidance.

When I answered the phone, the unhappy husband told me that he and his wife assumed that she could change her option when she terminated. So, she accepted the default and went on her merry way. Now, she will be receiving a lump sum that they don't really need right now and paying about half of it to various governments in the form of taxes.

Here's the idea. An employer could choose to go all the way or just do part of this.

Get an outsider like me who understands executive rewards and the 409A and other tax implications to help communicate to your executive group. In what I would term a perfect world (assuming that the employer chooses to not do the communication themselves), here is what would be entailed:

• Provide the outside consultant with the plan provisions and data for all the parts of the rewards package that you would like covered (SERP, deferred compensation plan, equity compensation, cash compensation, severance, change in control, etc.)
• Invite your executive group to a meeting. In that meeting, the outside consultant presents to the group generically on those elements of the rewards package. In that meeting, each executive, will get a summary/informal statement of their rewards package showing values and costs. The executives will place greater value on their rewards packages when they know how much they are worth and how much you are spending on them.
• With signed waivers (consulting, not legal, tax or accounting advice), allow executives to have individual meetings with the outside consultant after the group meeting. Let them ask questions about what they can change and when, what are their options, and what are their restrictions?
• These meetings can cover as much or as little of the executive rewards package as you would like, but the idea is to use the money that you are spending on executives for executives, not for the government.

Consider it. Let me help.

To Defer or Not to Defer, That is the Question

Last week, I wrote about the American Taxpayer Relief Act more commonly referred to as the Fiscal Cliff deal. While it avoided reversion to the pre-Bush era marginal tax rates for most Americans, it certainly included a lot of tax increases. Here we will focus on nonqualified deferred compensation (NQDC). Does it make more sens to defer or less sense to defer?

First, the withholding rate on supplemental wages in excess of $1 million in the aggregate increased to 39.6%. For supplemental wages up to $1 million, the withholding rate remains at 25%, What are supplemental wages? Generally, they are pay to an employee that is not part of a regular wage. They include overtime, bonuses, and distribution of nonqualified deferred compensation among other things. Ultimately, the taxes that a taxpayer pays are determined based on a number of factors, but the amount that they will see in a check for supplemental wages will decrease for particularly high recipients of supplemental wages.

Second, the OASDI portion of Social Security tax returned to 6.2% after being at 4.2% for a few years. This is the percentage of your paycheck that goes to Social Security on earnings not in excess of the Social Security Wage Base ($113,700 for 2013). The employer portion of OASDI remains at 6.2% of pay. For participants on NQDC plans, this is may be important because Social Security taxes are paid on NQDC generally in the year that such compensation is both vested and reasonably ascertainable. For most plans, that is the date when vested. For certain more complex plans such as DB SERPs, the amount may not be reasonably ascertainable until the participant terminates employment.

Third, the Medicare or HI portion of Social Security taxes has increased largely to pay for the ACA or ObamaCare if you prefer. For single filers with wages in excess of $200,000 or those filing jointly with income in excess of $250,000, the amounts above those thresholds will see an increase in HI tax from 1.45% of excess wages to 2.35% of excess wages. Additionally, there is a new 3.8% surtax on investment income such as capital gains from the sale of stock.

So, how do you know whether to defer or not to defer? It's a difficult question and the math is not as easy as we might like. Generally, the higher the marginal tax rate that you are paying, the more useful tax deferral is. Of course, there are many other factors that may influence your decision including your view of future tax rates, your need for the money in the short term, the investment return you can achieve and other factors that may be particularly germane to you as an individual.

Best of all will likely be compensation deferred in qualified plans such as 401(k), other defined contribution, and defined benefit if you are fortunate enough to have those opportunities.

In any case, for high earners, the new tax rates are more confiscatory than were the old ones, but your guess is as good as mine with respect to where they will be in the future.

Higher FICA Taxes on the Horizon

Health care reform in the guise of the Patient Protection and Affordable Care Act (PPACA) came to us with many new benefits. In order to pay for those benefits, the government had two options -- cut costs or raise revenue (spelled T-A-X). Here we talk about one of those new taxes.

Beginning January 1, 2013, high earners will be required to pay additional HI (Medicare) taxes under the FICA program. The additional tax is 0.9% of compensation in excess of $200,000 for individual filers or $250,000 for couples filing jointly. The employer portion of FICA will not increase.

First, this is going to need to be administered differently from traditional FICA taxes which generally are paid through payroll deduction. Here, your employer has no obligation to know how you file (in fact, you don't need to decide until you actually file), and your employer has neither the obligation nor the right to know your spouse's income. So, presumably, higher earners will simply have an additional tax tacked on to their Form 1040.

Think about this. What are FICA wages. Generally, they are compensation first vested and reasonably ascertainable in a year. For most deferred compensation plans, the amount of compensation that has been deferred is reasonably ascertainable. However, for plans such as defined benefit SERPs or for certain stock plans, this may not be the case. Regulations under Code Section 3121(v) allow taxpayers to early include such deferred compensation. In the case of individuals with significant SERP benefits in particular, they may want to discuss the possibility of early inclusion with their employers. While the tax hit for 2012 could be meaningful, it may lessen the long-term blow.

On the other hand, we don't yet know the outcome of the 2012 presidential election. Mitt Romney has pledged to repeal PPACA if elected. Its repeal would eliminate this tax.

Planning isn't as easy as it used to be.

The Social Security Tax Cut May Not Apply to You

Congress has reached a new level of confusing the American public. We have the new 2-month Social Security tax cut. And, it applies to all working Americans (except those like Senators and Representatives whose wages as elected officials I think are exempted from Social Security). So, for the months of January and February, we all get a decrease of 2% in our Social Security taxes. Fantastic!

Now, for some explanation. Generally, a person pays into the Social Security system at the rate of 7.65% of pay up to the Social Security Wage Base (I believe that is $110,100 for 2012). Above that level of wages, a person pays in at the rate of 1.45% of pay. And, for each dollar that a person pays in, their employer pays in an equal amount. If you are self-employed, you are both the employer and the employee, so you pay both parts.

Now, that sounds unfair, doesn't it, that you stop paying in the Old-Age, Survivor and Disability Insurance part (the first 6.2%) after your pay reaches the wage base? Well, you do need to consider that any pay that you receive that is above the wage base is not used in computing your eventual Social Security benefit. For those who are still with me, the other 1.45% is used for Health Insurance, i.e., Medicare.

Here is the good and fair news -- we all get that that cut in our OASDI (the 6.2% piece) during the months of January and February 2012 from 6.2% to 4.2%. But, some of us are deemed to apparently have no need for the extra 2%, so we have the honor of getting to pay a recapture tax, an increase to your federal income tax.

Yeehaw, gotta love it, a recapture tax. I know, what in the world is a recapture tax. Read on, poor reader.

Start by dividing $110,100 (the wage base) by 12 (to get a monthly rate) and you get $9,175. Double that to get a two-month rate and you are up to $18,350.

Now, suppose your Social Security wages for January and February are more than $18,350. [For those who aren't sure, Social Security wages look a lot like your gross pay before taxes are taken out. If you pay for certain welfare benefits on a pre-tax basis, they get taken out. And, if you defer compensation to a 401(k) or similar plan or even to a nonqualified deferred compensation plan to the extent that the amount is vested, those get included.]

If you are fortunate enough to still have your Social Security wages for that two-month period exceed $18,350, then you have the honor of paying a recapture tax calculated as follows:

1. Subtract $18,350 from your Social Security wages for the months of January and February combined. If the answer is 0 or less, then this doesn't apply to you. If the answer is greater than $18,350, then call it $18,350.
2. Take the result from step 1 and multiply it by 2%
3. This is the additional income tax that you will owe for 2012 and it is called a recapture tax.

Think of the scenarios. Lots of companies pay bonuses for your performance during the previous year (2011, in this case) during January or February. For people with base pay less than $110,100, your bonus could put you into recapture territory. Maybe you are fortunate enough to be entitled to a really big bonus for 2011 paid during January or February 2012. It might run through recapture territory into I-Don't-Owe-Recapture-Taxes-On-This Territory. And, then, there are the people whose bonuses will get paid during the first half of March. They get the old-fashioned treatment.

Got it? Good!

Now, think about your paycheck. If you are like lots of Americans, the payroll of your company gets handled by an outside provider. And, miraculously, once a week, once every two weeks, once or twice every month, the right amount of pay gets deposited electronically into your checking (or savings) account. Hmm, do you think that will happen now?

The IRS thinks that it may not. In fact, they have already published rules for companies and individuals that mess this up. Doesn't that just build up your confidence?

So, why do we have this nonsense? In my opinion, it's all because our government no longer chooses to govern. Instead, the two major parties wage a constant battle to see which can find a way to embarrass the other. Does it matter if a law is a good law? Of course not. Does it matter if the law can be administered? Of  course not. Does it matter if the law says what it is purported to say? Of course not.

The Democrats appear to have won this game of shame. It's not their first win. But, Republican lovers shouldn't feel left out. They have won the shame game about the same number of times.

So, now we have a middle-class tax cut ... unless your bonus gets paid at the wrong time, or unless you make too much overtime during January and February, or unless ...

Washington, We Have a Problem

I reported last week on the American Jobs of 2011, President Obama's landmark jobs legislation introduced to the country during a joint session of Congress last Thursday night. In a stunning act of name-stealing, Representative Louie Gohmert (D-TX) has introduced HR 2911 -- The American Jobs Act of 2911.

Representative Gohmert's bill is not nearly as thick as President Obama's, but each, in its own way, purports that it will achieve the same goals.

The good news is that I can explain all of the provisions of Representative Gohmert's bill to you here in a clear and concise manner.

1. Effective for taxable years beginning after December 31, 2011, the corporate income tax shall be zero percent of corporate income.
2. Effective for taxable years beginning after December 31, 2011, the amount of the Corporate Alternative Minimum Tax shall be zero.

That's it. This is not an April Fool's joke.

Whose bill do you like better?