Chapter Six Attracting and Motivating Employees and Managers: Company and Employee Tax Planning

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Chapter SixAttracting and Motivating Employees
and Managers Company and Employee Tax Planning
Strategic Tax Planning
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Introduction

• Goals of compensation To improve labor
  productivity over that derived from simply paying
  wages.
• Two Fundamental Approaches
• Better matching rewards with employee needs
• Align employee performance with the firms
  strategic goals

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Executive Compensation

• Firms need to compete by offering better
  compensation match to combat the scarcity of good
  corporate executives.
• Average large company CEO receives 20 million in
  annual compensation.

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Six basic components

• Annual base wages
• Year-end bonuses
• Long-term equity participation
• Deferred compensation
• Enhanced retirement and other fringe benefits
• Employment security

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Executive Compensation

• Each component taxed differently
• Salary should not be used for direct motivator
  for future performance.
• Equity compensation is more preferred.
• Stock options carry a strong incentive effect.

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Nonexecutive Employee Compensation

• Nonemployees are considered contract labor where
  tax treatment needs to be distinguished.
• Typically deductible just like employee
  compensation.
• More employment tax savings might be obtained by
  having workers classify as self-employed
  contractors instead of employees.
• Considered employees if they have right of
  control.

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Nonexecutive Employee Compensation

• Attempting to classify employees as contractors
  may be a poor tax strategy.
• Firm pays less in direct taxes however pay more
  in implicit taxes.
• Employee Leasing can reduce employment and
  transaction costs by having the firm pay only
  leasing fees to the leasing firm.

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Nonexecutive Employee Compensation

• Controlling the unemployment tax rate can also
  reduce costs.
• Reducing employee dismissals can reduce the
  unemployment claims for the firm.
• In nonexecutive compensation, firms can reduce
  taxes if they take advantage of tax breaks
  relating to hiring new employees.

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Nonexecutive Employee Compensation

• Employee Compensation Packages
• Firms indifferent to different compensation types
  because firms get tax deductions regardless of
  the form of compensation.
• Noncash benefits available to all employees are
  not taxed to the employee.
• Depending on the employees tax rate, stock
  options or after tax benefits may be preferred.

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Perquisites

• Nature of the firm determines its labor-capital
  intensity.
• There are transaction costs associated with
  noncash compensation such as pension plans and
  medical plans.
• Benefits used can have attract and motivate
  employees.

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Pension and Profit Sharing Plans

• Pension plans can be defined benefit or defined
  contribution.
• In a defined contribution plan, employer makes
  annual contribution to a trust account setup for
  the benefit of the employee.
• Returns in a pension trust is not taxed and
  managed by financial institutes or financial
  intermediaries.

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Pension and Profit Sharing Plans

• Pension funds can be invested in the companys
  own stock.
• Reduces number of share publicly held for the
  company.
• Motivates employee to work harder.
• Profit-sharing are structured to pay employees a
  percentage of earnings each year

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Current and Deferred Compensation

• 401k allows employee to set aside pre-tax dollars
  into a retirement-type account.
• Earnings are untaxed until they are withdrawn.
• Maximum contribution per year

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Limits on Deductibility on Executive Compensation

• Executive Compensation comes in three forms.
• Salary
• Bonus
• Stock Options
• Publicly held corporations are denied deductions
  for the amount by which executives annual
  compensation exceeds 1,000,000, unless
  performanced based.

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Limits on Deductibility on Executive Compensation

• Another limit on executive compensation is the
  limited deductibility of golden parachute
  payments.
• Executives enter agreement is takeover occurs, a
  large amount of money must be paid to them.
• Profit for executive comes from the sale of stock.

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Limits on Deductibility on Executive Compensation

• Incentive Stock Option Plan are more tax
  beneficial to the executive but can be subjected
  to alternative minimum tax if exercise price and
  stocks fair market value is far apart.
• Stock Options keeps the firm keep control of the
  company from outsiders.

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Management Bonus Plans

• Bonus plans for executives are tied into
  financial accounting performance measures.
• Bonus Plans encourage short-run payoff projects
  and encourage managers to manipulate accounting
  information to increase earnings.
• Bonuses can be taxed as ordinary income.

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Management Bonus Plans

• If the firm or executive expects a tax change
  status, they can negotiate the timing of the
  bonus.

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Financial-Statement/Finance Versus Tax Strategy
Trade-Offs

• Tax Savings from compensations are reported as
  additional cash on the balance sheet and reduced
  income tax expense on the income statement.
• Employers should be concerned about the timing
  and the amount of income tax deduction and
  relevant cash requirements.

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Financial-Statement/Finance Versus Tax Strategy
Trade-Offs

• Opportunity to obtain capital gain rates via
  stock option programs is a motivator for
  compensation.
• Employee will view deferral of compensation as a
  benefit when paid a reasonable salary and bonus.
• Employer will have affinity to nonqualified stock
  option due to favorable financial statement
  treatment and income tax deductions.

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SAVANT Framework

• Case You are trying to hire top executive away
  and would bring in 5 million to the company.
  Your firm has a tax NOL which is expiring.
  Current compensation at the competitor firm is 1
  million in salary. What sort of contract should
  be offered?

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SAVANT Framework

• Strategy
• Hiring executive away from competitors keeps a
  strategic advantage.
• Anticipation
• Assure that stock value will go up in response to
  performance.
• Value-Adding
• Financial-accounting charge to earnings should
  not exceed 5 million per year
• Negotiating
• Company would prefer to defer more compensation
  till next year thus have to pay the executive
  more. Stock options is no viable also because she
  may not see any tax advantage.