MBAO 6600 - Executive Compensation Executive Salaries: Tax Issues Highly Paid Employees (IRS Definition): One or more of the following satisfy the definition:

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MBAO Executive Compensation 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 Executive Compensation 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 Executive Compensation 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 Executive Compensation 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 Executive Compensation 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 Executive Compensation 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 Executive Compensation 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.