11

22

COMPENSATION & COMPENSATION & RETIRMENT PLANNINGRETIRMENT PLANNING

Employee vs. independent contractorSalariesEmployee fringe benefitsEmployee stock optionsEmployment-related expensesRetirement plans

33

Employee vs. Independent Employee vs. Independent ContractorContractor (1 of 3) (1 of 3)

Tax consequences if taxpayer classified as an employee Employer

Must pay ½ of FICA and payroll taxes. Responsible for withholding taxes. Must provide employee benefits

Taxpayer Only pay ½ of FICA (no SE tax). Employment-related expenses deductible as

miscellaneous itemized deduction subject to 2% AGI limitation.

44

Employee vs. Independent Employee vs. Independent ContractorContractor (2 of 3) (2 of 3)

Tax consequences if taxpayer classified as an independent contractor Employer

Pays no FICA or payroll taxes, no withholding. No employee benefits

Taxpayer Must pay SE tax (2x FICA). Employment-related expenses deductible as for AGI

deduction (fewer restrictions).

55

Employee vs. Independent Employee vs. Independent ContractorContractor (3 of 3) (3 of 3)

Factors used to determine if employer-employee relationship exists: An employer controls details of how work is

performed. An employer can discharge an employee without

legal liability (no breach of contract). Employers furnish tools &/or place of work. Employee income based on time spent rather than

task performed.

66

SalariesSalaries(1 of 2)(1 of 2)

Employers may deduct wages if ordinary business expense. Exception: cash compensation > $1M to a

top-5 officer is not deductible unless it is performance based.

Wages are taxable to employees at ordinary rates.

Family compensation issues discussed in Chapters 9 & 10.

77

SalariesSalaries(2 of 2)(2 of 2)

Foreign earned income exclusion. U.S. citizens (or permanent residents) who

reside and work overseas. Must be physically present in foreign for 330 of 365

day period. Exclude up to $80,000 (2003 limit).

Exclusion based on portion of year physically present outside U.S.

Add’l exclusion for foreign housing allowance. Cannot claim FTC on excluded income.

88

Employee Fringe BenefitsEmployee Fringe Benefits(1 of 2)(1 of 2)

General rule: Fringe benefits taxable.Types of fringe benefits excluded:

Providing a social welfare benefit Health, life ins, child care.

Hard to enforce anyway De minimis rules, discounts.

Non-discriminatory, or Necessary for job

Moving expenses, supplies at work.

99

Employee Fringe BenefitsEmployee Fringe Benefits(2 of 2)(2 of 2)

Cafeteria plans Employee chooses from several options.

Taxable if employee chooses to receive cash instead of benefits.

Specific examples: Health insurance not taxable if nondiscrim. Group term life ins. up to $50,000. Dependent care assistance up to $5,000.

1010

Employee Stock OptionsEmployee Stock Options(1 of 2)(1 of 2)

Nonqualified stock option (NSO). NO tax owed on date of grant. Employee tax consequences:

Salary income on exercise date equal to difference in FMV of stock and exercise price.

Basis in stock is FMV at exercise date. Capital gain/loss on subsequent sale.

Employer tax consequences Tax deduction equal to employee income on exercise

date. Not subject to nondiscrimination rules.

1111

Employee Stock OptionsEmployee Stock Options(2 of 2)(2 of 2)

Incentive stock option (ISO). NO tax owed on date of grant (AMT adj). Employee tax consequences:

No salary income on exercise date. Basis in stock is FMV at exercise date. Capital gain/loss on subsequent sale.

Employer tax consequences No deduction ever. Subject to nondiscrimination rules.

1212

Employment-Related Employment-Related ExpensesExpenses (1 of 2) (1 of 2)

Employee expenses Unreimbursed expenses are itemized

deductions. Deductible to extent they exceed 2% of AGI. Combined with other misc. itemized

deductions such as investment expenses.

1313

Employment-Related Employment-Related ExpensesExpenses (2 of 2) (2 of 2)

Moving expenses Deduct unreimbursed expenses as a FOR AGI

deduction. New job mileage and time of work requirements.

Distance from old home to new job must be more than 50 miles greater than distance from old home to old job.

Must work at new job 39 or 52 weeks (or 78 of 104 weeks for self-employeds)

Deduct cost of moving furniture and cars, moving family (but not meals).

1414

Retirement PlansRetirement Plans

Basics of retirement planningQualified plans in generalEmployer plansSelf-employed plans: KeoghTraditional IRARoth IRA

1515

Basics of Retirement Planning

Main concepts to learn in this course: Qualified plans provide DEFERRAL (Roth

IRA provides exemption) of tax on earnings. The compounding effect of this is BIG. Withdrawal cannot begin before age 59 ½

(w/o penalty) but must begin after 70 ½. Some exceptions for first-time home buyers and

payment of higher ed. exp.

1616

Qualified Plans in General

General rules for qualified plans Plan cannot be discriminatory; $ limits. Current earned income contributed to plan is not

currently taxed. (IRA, 401K, Defined contribution plans).

Employer deduction for funding plan. Plan is tax exempt, so earnings are not taxed as

they accumulate. Retired person taxed on all withdrawals. Premature withdrawals 10% excise tax.

1717

Employer Plans

Qualified plans Defined benefit Defined contribution 401(k)

Nonqualified plans

1818

Defined Benefit Plans

Benefits to be received predetermined.Employer assumes risk of ROI.Type of plan that deals with SFAS87.Annual pension limited to the lesser of

100% of avg. comp. for last 3 years, or $160,000 (in 2003).

Larger deductions than DC plans if started close to retirement.

1919

Defined Contribution Plans

Employer contributions predetermined.Employee assumes risk of ROI.Yearly contribution limited to lesser of

100% of annual compensation or $40,000 (in 2003).

Larger deductions than DB plans if started with many years to retirement.

2020

401(k) Plans

Contributory plan: employer & employee both contribute.

Noncontributory plan: only employee contributes.

Employee contribution limit: Lesser of 100% of salary or $12,000 in 2003.

2121

Nonqualified Plans

Employee delays paying tax until receive money.

Corporation delays deducting salary expense until pay money.

Often used by top executives.Since nonqualified, these plans CAN

discriminate!

2222

Self-Employed Plans: Keogh

Contribute up to the lesser of 100% of earned income from self-

employment $40,000 in 2003.

Must not discriminate. If owner has employees then he/she

must provide retirement benefits to them.

2323

Traditional IRA(1 of 2)

Individuals contribute the lesser of $3,000 or 100% of compensation

Each spouse may contribute $3,000 if combined earned income = $6,000.

Deduction for contribution is limited: If taxpayer participates in a qualified plan

Phaseout range for MFJ $60k-$70k in 2003. If spouse participates in a qualified plan

Phaseout range for MFJ $150-$160k in 2003.

2424

Traditional IRA(2 of 2)

IRA withdrawals If all contributions deductible

All withdrawals ordinary income. If some contributions were nondeductible:

Nontaxable withdrawal % = unrecovered investment / current yr IRA value.

Early w/d subject to 10% penalty, except: $10,000 withdrawal for “first-time homebuyer.” Funds to pay higher education expenses.

2525

Roth IRA

NO deduction for contributions, but NO tax on distributions.

Individuals contribute the lesser of $3,000 or 100% of compensation

Each spouse may contribute $3,000 if combined earned income = $6,000.

No plan participation restrictions. Phased out for MFJ $150-$160k in 2003.

Same w/d restrictions as Trad IRAs.

2626