CFP Exam Prep Cards - Section 3 - Employee Benefits Planning

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EMPLOYEE BENEFITS PLANS Group term insurance must satisfy four requirements:: 1) provide general death benefit excudable from income
2) provided as compensation for services performed
3) policy is carried by employer
4) amount of insurance computed by formula
EMPLOYEE BENEFITS PLANS Group term: Expensive? Easy to administer?: - most inexpensive form of group insurance
- easiest and least expensive to administer
EMPLOYEE BENEFITS PLANS Group term - insurability: evidence of insurability is not required
EMPLOYEE BENEFITS PLANS Group term - what if employee leaves?: terminated employee may convert the group term policy to an individual cash value policy without evidence of insurability
EMPLOYEE BENEFITS PLANS Group Permanent - Three different types of group permanent insurance: 1) group paid up
2) group ordinary
3) group universal life (UL)
EMPLOYEE BENEFITS PLANS Plans can be established as one of two types (2):: 1) Contributory Plan - employee pays some of the cost

2) Noncontributory plan - employer pays entire cost
EMPLOYEE BENEFITS PLANS Group Term Tax Implications (on premiums)Less than $50k coverage: - Premiums deductible by employer

- Premiums NOT taxable to employee
EMPLOYEE BENEFITS PLANS Group Term Tax Implications (on premiums)More than $50k coverage: -Premiums deductible by employer

-Premiums taxable to employer
EMPLOYEE BENEFITS PLANS Group Permanent Tax Implications (on premiums) -Any face amount: -Premiums deductible by employer (if employee has vested rights to insurance)

-Premiums taxable to employee
EMPLOYEE BENEFITS PLANS Group disability insurance - Income Tax IMplications (premiums and benefits): -Premiums deductible to employer

-Premiums paid by employer are NOT taxable to employee

-Benefits recieved by employee ARE TAXABLE if paid by employer
Cafeteria Plan: Written plan under which employees can choose between two or more benefits consisting of two mandatory components
What are the two mandatory components of a Cafeteria Plan?: 1) Cash - taxable as compensation

2) One or more qualified benefits
What are the qualified benefits employees can choose from in a Cafeteria Plan? (2): 1) Medical expense benefit via individual or group (NONTAXABLE)

2) Cost of group term in excess of $50k (TAXABLE)
What is a Flexible Spending Account (FSA)?: Type of cafeteria plan funded through salary reduction which allows them to fund certain benefits with PRE TAX dollars

-KEY PHRASE: Use it or Loose it! Employer gets the forfeiture
Taxability of Fringe Benefits:: Taxed on Fair Market Value of certain noncash fringe benefits
Treated as compensation
Included in gross income
(Country Club Dues, Season Tickets)
What is a VEBA (Voluntary Employee Beneficiary Association)?: Multiple-employer trust that can be used to prefund employee benefits - deposits to trust are immediatly tax deductible
Incentive Stock Options (ISO) Transferability?: Only the employee can exercise during his life. Can be transferred at death
Nonqualified Stock Options (NSO) Transferability?: Option is transferrable to family members
EMPLOYEE STOCK OPTIONS Vesting Schedule Staright Vesting:: Same percentage of option become exercisable each year
EMPLOYEE STOCK OPTIONS Vesting Schedule Cliff Vesting:: all at once
EMPLOYEE STOCK OPTIONS Vesting Schedule Step Vesting:: varies year to year
EMPLOYEE STOCK OPTIONS Vesting Schedule Performance vesting:: vested in the year the company acheives a particular goal
EMPLOYEE STOCK OPTIONS Vesting Schedule Early vesting (accelerated exercise):: allowed to immedeatly exercise options when granted. For each option exercise they recieve a share of "restricted" stock subject to a holding period
EMPLOYEE STOCK OPTIONS Expiration on options: -Generally employees have 10 years (or less) to exercise

-Terminated employees may have 30 to 90 days
EMPLOYEE STOCK OPTIONS Incentive Stock Options (ISO) Tax Implications - Upon Grant: no income tax due
EMPLOYEE STOCK OPTIONS Incentive Stock Options (ISO) Tax Implications - Upon Exercise: No income for calculating regular tax
EMPLOYEE STOCK OPTIONS Incentive Stock Options (ISO) Tax Implications - Upon QUALIFYING Sale: Regular tax - LTCG difference between FMV at time of sale and exercise price
EMPLOYEE STOCK OPTIONS Incentive Stock Options (ISO) What are holding period requirements for a QUALIFYING SALE?: Shares must be held at least 1 year after the option is exercised
At least 2 years after the option grant
EMPLOYEE STOCK OPTIONS Incentive Stock Options (ISO) Tax Implications What is penalty if holding requirements are not satisfied?: Then a portion of the employee's profit is taxed as compensation and the employer is allowed a deduction for that compensation
EMPLOYEE STOCK OPTIONS Non-Qualified Stock Opt (NSO) Tax Implications - Upon Grant: no income tax is due
EMPLOYEE STOCK OPTIONS Non-Qualified Stock Opt (NSO) Tax Implications - Upon exercise: employee realizes income equal to difference between grant (exercise) price and FMV at time of exercise

THIS DIFFERENCE IS CALLED THE BARGAIN ELEMENT
EMPLOYEE STOCK OPTIONS Non-Qualified Stock Opt (NSO) At time of exercise what is company required to do?: Company must withhold federal and state tax

FMV at time of exercise becomes the new cost basis
EMPLOYEE STOCK OPTIONS Non-Qualified Stock Opt (NSO) Tax Implications - Upon Sale: only additional tax if selling price exceeds the share basis
EMPLOYEE STOCK OPTIONS Non-Qualified Stock Opt (NSO) Tax Implications - What is an 83(b) election?: employee makes an election to include in income the FMV of the stock, less any amount paid for the stock at the time the stock is issued
Employee Stock purchase plan (ESPPs) What are they?: -stock option plan under IRC section 423

-allows a company to sell stock to employees at a discount from market price
EMPLOYEE STOCK PURCHASE PLANS Basic provisions (4): 1) cannot be given on discrimanatory basis
2) ONLY employee can purchase
3) Purchase can be as low as 85% of FMV
4) Max FMV of stock cannot exceed $25,000
EMPLOYEE STOCK PURCHASE PLANS Tax implications for GRANT, PURCHASE and SALE:: Grant - no inc tax
Purchase - no inc tax
Sale - Can be income or LTCG depending on holding period requirements (as for ISOs)
STOCK OPTIONS: Which plans can discriminate and which cannot discriminate? ESPP, ISO, NSO?: ESPP - nondiscriminatory

ISO / NSO - discriminatory
Phantom stock - Basic provisions: -Employee is awarded units analogous to shares using a formula (based on comp)
- Not real stock but method of tracking (no dilution of shares)
-no recognized income to employee
-cannot specify date on which to exercise stock
-upon exercise (usually given cash not stock) taxed as ordinary income
EMPLOYEE STOCK PLANS Stock appreciation right (SAR) - Basic provision: Like Phantom stock except:
-offered together with stock option
-gives employee right to appreciation in the stock after the grant date
-employee has right to decide when to exercise SAR
-taxed as ordinary income at exercise
EMPLOYEE STOCK PLANS Restricted Stock - Basic Provision: -granted to employee at not cost or at a bargain price with restrictions
-can be given on discriminatory basis
-form of incentive compensation to key employees
EMPLOYEE STOCK PLANS Junior stock - Basic Provisions: Restricted stock that can be converted into common stock of the company but only if performance goals are reached
NONQUALIFIED DEFERRED COMPENSATION Rabbi Trust: -Irrevocable trust set up by employer to set funds aside prior to retirement to pay retirement benefits in an irrevocable trust
-Trust and benefits cannot be changed even in hostile takeover
-Not protected from bankruptcy
NONQUALIFIED DEFERRED COMPENSATION Pure deffered compensation plan:: -Pure deferred compensation plan
-employee agrees to defer a specified portion of compensation in exchange the employer pledges to pay a benefit in the future equal to the amount deferred and a predetermined rate of interest
-rabbi trust often used to fund pure def comp plan
NONQUALIFIED DEFERRED COMPENSATION Supplemental Executive Retirement Plan (SERP): -employee (executive) does NOT give up current dollars for later benefits
-instead company pledges to provide the benefit often above and beyond companies qualified retirement plan calculations
NONQUALIFIED DEFERRED COMPENSATION Secular Trust: -irrevocable trust set up to provide nonq benefits to an employee
-employer contribs are protected from creditors, bankruptcy, insolvency, takeover, merger, etc.
-contributions are taxable to employee
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS Buy-Sell Agreements: -make sure an estate can sell a business interest for a reasonable price
-contains wording that binds the owner of a business to sell their share of it at a specified price to a pre-set buyer (usually partners in the business)
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS Cross-Purchase agreement: -Each owner purchases an insurance policy on the other owners
-Policy owner is also bene
-upon death of an owner his estate will sell and other owners will buy the business interest
-insurance proceeds are used to fund the agreement
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS Entity Agreement (also called Stock-Redemption Agreement): -The business (not owners like Cross-Purchase) buys the insurance on the owners
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS Business overhead disability plan: -used to cover ongoing operating costs of a business while owner is disabled
-premiums are deductible and benefits are taxable
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS Executive/owner benefits (Executive-Bonus Life Ins): Allows an employer to provide life insurance protection for a selected employee on a tax-deductible basis
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS Split-dollar: -allows an employer to provide life insurance for a selected employee
-The death benefit is split as follows:
(a) corporation recieves return of premium (cash surr value)
(b) beneficiary receives the net amount of risk
-employer and employee share premium
EMPLOYER/EMPLOYEE INSURANCE ARRANGEMENTS Key employee insurance: -Insurance on a key employee (business owns and is bene of)
-Premiums NOT deductible to business
-Death bene are tax free
-Primary purpose is to:
1) protect business against loss of income
2) provide funds for locating and traning replacement

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