1. What is it? When is it indicated?
Employers can make loans available to executives for specified purposes
When executives need cash to meet needs in special situations
When is it indicated?
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2. Common Loan Situations
A mortgage or ‘bridge’ loan when executive is relocating
College or private school tuition for members of executive’s family
Purchase employer stock
Meeting extraordinary needs (e.g. medical, tax, etc.)
Purchase life insurance
Complete expensive purchase (e.g. car)
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3. Advantages
No tax advantages but usually cash is made available at favorable interest rates
Some loans exempt from complex tax rules for “below market loans”
Employer’s costs for making loan usually low
Employer can discriminate regarding term, amount, condition of loans
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4. Disadvantages Complex tax rules for ‘below-market’ loans
Unfavorable tax treatment of term loans; employee must include substantial portion of loan in income at times
Employer must bear cost of
loan administration
loan default
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5. Tax Implications If loan is
below market
compensation related
a demand loan
Interest is treated as 3 transactions – the actual transaction plus 2 ‘deemed’ transactions
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6. Tax Implications Actual transaction:
Interest actually paid by borrower is taxable income to company (lender) and may be tax deductible by borrower, subject to usual limitations on interest deductions
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7. Tax Implications “deemed transactions”
Employer treated as if paid additional compensation to employee equal to difference between actual rate of interest and “applicable federal rate”
this “additional compensation” is tax deductible to employer taxable income to employee
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8. Tax Implications “deemed transactions” (cont’d)
Borrower is treated as if paid amount for (2) to employer – this amount is
additional taxable income to employer
deductible by borrower, subject to usual limitations on interest deductibility
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9. Tax Implications Exceptions to tax rules
Mortgage and bridge loans that meet certain specific qualifications
De minimis loans
No tax effect if taxpayer can show interest arrangements will have no significant effect on federal tax liability of lender or borrower
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10. ERISA and Other Regulatory Implications
No ERISA requirements to meet - executive loans are neither welfare nor pension plans
Federal “Truth in Lending” laws may apply
Sarbanes-Oxley rule prohibits any publicly traded corporation from making a personal loan to any director or executive officer
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11. Alternatives
Loans by employers for full market rates; “bonus” interest cost to executive as additional compensation
Guarantees by employer of regular bank loans taken out by executives
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12. Discussion Questions
What requirements must be met to qualify for the mortgage loan exception and for the bridge loan exception?
How is a term loan to an executive treated for tax purposes?
Discussion Questions:
1. See pages
2. See page 418
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