Chapter Objectives Be able to: Explain what factors to consider when evaluating different compensation packages. Identify and explain the different types of indirect compensation available and their tax implications. Identify and explain the different types of deferred compensation available and their tax implications.

Basic Objectives and General Tax Principles of Employee Compensation The fundamental objective of a compensation program is to provide maximum satisfaction to employees at the least possible cost. An employer can offer non-taxable and tax-deferred compensation items to create increased after-tax value. Also, the cost savings can be retained by the employer, shifted to an employee, or shared between them. In order to make the fullest use of the available tax preferences, the employee’s tax position must be taken into account. It is also important to recognize that different forms of compensation will have different values to different employees.

Indirect Employee Compensation Although indirect compensation is fully deductible to an employer, it can vary from taxable to tax-free for employees. Some examples of taxable benefits are: personal use of employer’s auto, incentive awards (such as holiday trips), low-interest loans, premiums under provincial hospitalization plans, and tuition fees. Even though these benefits are fully taxed, cost savings can result if the employee needs the particular benefit and the employer may be able to acquire the benefit at a cost lower than that available to an employee. Some examples of non-taxable benefits are: premiums under private group sickness plans, reimbursement of moving expenses, and discount on merchandise. Not only are these benefits tax-free, the employer may be able to acquire the benefit at a cost lower than that available to an employee.

Deferred Employee Compensation Given the highly progressive tax rates imposed on individuals, deferred compensation may be quite beneficial. The two main advantages of deferred compensation are: the compensation payments may be delayed until a time when there are lower tax rates, such as retirement; and the investment returns may accrue on an pre-tax basis, rather than an after-tax basis. The three categories of deferred plans are registered plans, non-registered plans, and stock-based plans.

Registered and Non-registered Plans The two registered deferred compensation plans are registered pension plans (RPPs) and deferred profit sharing plans (DPSPs). A limited amount of contributions are deductible by an employer and these contributions are not taxable to the employee until withdrawn from the registered plan. Furthermore, investment returns on the accumulated contributions are not taxed to the employee until withdrawn from the registered plan. Non-registered plans include employee profit sharing plans, employee trusts, salary deferral arrangements,and retirement compensation arrangements. There is no tax relief granted for the amounts deferred and, thus, they are rarely used.

Stock-based Plans Stock-based plans are designed to provide employees with long-term incentives and rewards by giving them an opportunity to purchase shares which will grow in value as corporate profits increase. The four types of plans are: stock option plans; stock purchase plans; stock bonus plans; and phantom stock plans. Stock option plans provide the employee with the right to purchase shares from the corporate treasury at a specified price for a specified period of time. The benefit is computed as the difference between the share’s value and the option price. The timing of the benefit will vary depending on whether the option price was lower than the share’s value at the time of granting the option. Capital gains will be computed if, and when, the shares are sold for a profit.

Stock-based Plans (continued) In a stock purchase plan, funds are loaned to employees to purchase stock from the corporate treasury. There is no discount provided and, thus, no benefit to calculate. Capital gains will be computed if, and when, the shares are sold for a profit. In a stock bonus plan, bonuses are paid in shares rather than cash. The amount of a bonus is included in income regardless of whether it is paid in cash or shares. Capital gains will be computed if, and when, the shares are sold for a profit. In a phantom stock plan, points are granted to employees during a vesting period. At the end of the vesting period, the points are exchanged for a cash bonus. Stock is not issued in this type of plan.