5.1 Introduction

• Library: Corporations and Partnerships in Virginia (Virginia CLE) (2016 Ed.)

5.1 INTRODUCTION

5.101 In General. Decisions regarding executive compensation (as well as the compensation of other employees) require a balancing of a number of factors, including the value of the employee's services, the income tax consequences of various forms of compensation, and the effect of the form of compensation on other employees. Forms of compensation might include a variety of benefits in addition to a cash salary, some of which are taxable to the employee and some of which are not. Typical benefits include:

1.	The payment of a bonus based on profits, sales, or other measures of performance;
2.	Employee welfare benefits, such as health insurance, group life insurance plans, and disability insurance;
3.	Employee pension benefits, such as qualified and nonqualified deferred compensation arrangements;
4.	Ownership arrangements provided by stock options, stock bonuses, or participation in stock purchase plans; and
5.	Supplementary fringe benefits, such as pretax parking, company-provided automobiles, or vacation facilities.

From the business perspective, the goal of a "compensation package" might be summarized as follows: (i) to attract and retain qualified executives and employees at all levels of employment; (ii) to provide incentive for employees to carry out duties in an efficient and profitable manner; (iii) to encourage employees to equate or merge personal goals with the business's objectives so that the success of the company becomes synonymous with the success of the employee; and (iv) to compensate or provide other benefits with the most favorable income tax consequences.

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Certain kinds of benefits may be provided at lower income tax costs. For example, the corporation can provide accident and health insurance, life insurance within certain limits, and certain types of fringe benefits without a tax cost to the employee, even though the cost of providing the benefit is immediately deductible by the employer for income tax purposes. Similarly, qualified pension and profit sharing plans result in a current deduction to the corporation for contributions to the plan, but the individual employee is taxed only when the benefits are actually distributed, generally at retirement or other termination of employment. Other types of benefits are deductible by the employer only at the time the employee is required to include these benefits in income. This is true for nonqualified deferred compensation arrangements, nonqualified stock option plans, and certain types of fringe benefits.

The ideal compensation package for each employee depends upon the personal financial plans and needs of the individual. A different mix of direct compensation, deferred compensation, and welfare and fringe benefits would be desired by a younger executive than that desired by an executive nearing retirement age. The employer should recognize that the needs of one employee and the group as a whole are likely to change over time. Thus, the employer should anticipate revising the compensation package with the changing needs of the employees.

The ultimate goal is to match the objectives of the employer with those of the employee and to provide a compensation package that will, as much as possible, meet the objectives of both at the lowest possible income tax cost.

5.102 Employment Relationship. This chapter generally assumes that there exists an employment relationship. Some of the compensation, welfare, and fringe benefit arrangements considered in this chapter will not be applicable to a business conducted as a partnership, limited liability company, or as a sole proprietorship. In addition, several of the welfare and fringe benefit arrangements are not available for more-than-two-percent shareholders of an S corporation or shareholders of a limited liability company since these individuals are treated like partners for income tax purposes. The availability of favorable tax treatment is one of the factors to be taken into account in determining whether to operate...