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Executive Salaries: Tax Issues

Executive Salaries: Tax Issues. Highly Paid Employees (IRS Definition): One or more of the following satisfy the definition: 1. Earns > $50K/year & salary in top 20% of all employees 2. Earns > $75K/year 3. Owns > 2% of the firm equity Highly paid employee status impacts:

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Executive Salaries: Tax Issues

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  1. Executive Salaries: Tax Issues Highly Paid Employees (IRS Definition): One or more of the following satisfy the definition: 1. Earns > $50K/year & salary in top 20% of all employees 2. Earns > $75K/year 3. Owns > 2% of the firm equity Highly paid employee status impacts: -Qualified benefit plan status and size of contribution -Opportunity to take unpaid leave under FMLA MBAO 6600 - Executive Compensation

  2. Executive Salaries: Forms of Taxes Ordinary Income Tax Rate Joint Income Single Income 15% 0-$42K 0-$25K 28% $42K-$102K $25K-$61K 31% $102K-$156K $61K-$128K 36% $156K-$278K $128K-$278K 39.6% over $278K over $278K MBAO 6600 - Executive Compensation

  3. Executive Salaries: Forms of Taxes Capital Gains Tax - Gains realized on sale of capital assets (such as stock) • Short-term capital gains (less than 12 months) • ordinary income tax rates (up to 39.6%) • Long-term capital gains (more than 12 months) • 20% tax rate MBAO 6600 - Executive Compensation

  4. Executive Salaries: IRC ruling Million Dollar Cap on Executive Salaries: • Section 162 (m) of IRC • No Corporate Tax deduction for annual compensation that exceeds $1 million • Applies to publicly held companies - CEO & next 4 highly compensation employees. Exceptions: • Stock options: shareholder approved, admin. by comp. committee > 2 independent people • Performance-based pay: same as stock options & performance formula for determining award MBAO 6600 - Executive Compensation

  5. Executive Salaries: Determinants(Gomez-Mejia & Balkin, 1992) • Size of Firm • Stage in Life Cycle • Start-up, Growth, Mature, Decline • Industry/Sector • Service/Mfg./High Tech • private/public/non-profit • Firm Performance - weak w.r.t. salaries MBAO 6600 - Executive Compensation

  6. Significance of Executive Salary • Salary represents the most stable source of income for the executive • Salary is a benchmark to determine pay mix: • Pay Mix = variable/fixed pay • Represents degree of risk & uncertainty in earnings • PM too small - executive is too “comfortable” with earnings not motivated to take risks • PM too large - executive is too much at risk, and overly focused or distracted by pay. MBAO 6600 - Executive Compensation

  7. Significance of Executive Salary Salary is the basis of other executive pay decisions 1. Design of bonus is a percentage of salary 2. Golden parachute (executive severance pay) is a multiple of the salary 3. Executive retirement plan uses salary in the formula for retirement income. 4. Executive life and disability insurance uses salary as a basis for computing the benefit to survivors. MBAO 6600 - Executive Compensation

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