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Executive Compensation

In a closely held business there are numerous ways to compensate executive officers. These options have various effects on a company's reporting procedures.

Cash Bonuses- Taxation of these is very simple. It produces ordinary income to the executive while producing a simultaneous deduction to the corporation. The most significant issue that occasionally comes into play is whether the amount of the cash bonus is reasonable in amount. Since this requires an actual cash outlay by the company, it is rare that the company could not justify the payment of a cash bonus. Exceptions, of course, are more likely if the new executive is also a family member of the owners. In addition to the offsetting income to the employee and deduction to the employer, computations, when attempting to be precise, must also take account of the various federal and state employment tax issues.

Deferred Compensation- Deferred compensation is not seen in closely held corporations as much as it is discussed. Generally, there is no net tax benefit to be obtained by deferring compensation in a closely held corporation. That is, whatever benefit is achieved by the employee through the deferral of compensation is met with a corresponding cost to the employer because of the deferral of the deduction. As indicated above, the recent enactment of Section 409A has raised the stakes, as well as complicated the technical compliance requirements, of creating deferred compensation plans for closely held businesses. Rather than being used as a tax incentive, deferred compensation plans generally are structured because of the business considerations and benefits that the deferred compensations plan might bestow. Creation of a deferred compensation plan tailored to the needs of a new executive may create the incentive necessary to attract the executive to the new employment situation. This could involve simply providing a tax benefit to the employee, or creating incentives for the employee whereby deferred compensation
amounts can be earned or increased based upon successful economic performance at the company level. These may or may not be subject to vesting or forfeiture provisions, which vary the incentive as well as impact the timing of the ultimate taxation of the amounts. A common use of deferred compensation that does hinge on the tax benefits is the use of deferred compensation as a disguised purchase price upon the termination of employment and ownership in a company. As a general rule, if a company repurchases an equity interest, the amounts used to make such payment would be part of the taxable income as determined at the entity level, while the payment of this amount does not produce a corresponding deduction. The employee treats part of such payment as a return of basis, with the excess generally being taxed at capital gain rates. Frequently an advantage for both parties can be obtained, with appropriate adjustments to the ultimate amount of the purchase price, if the purchase price is reduced and then replaced with a deferred compensation plan which, in effect, allows a portion of the purchase price to be paid with dollars that are currently deductible to the entity for federal income tax purposes.

Stock Options- Corporations have the ability to issue stock options that can be categorized as qualified or as nonqualified stock options. While these are frequently used with public companies with an actively traded stock market, they are less frequently used with closely held corporations. Rather, equity ownership in a closely held corporation is more commonly contained or regulated through stock bonuses and deferred compensation based upon stock performance.

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