1. 21 st Annual IL Statewide APA Conference August 22, 2014 Galley Kitchen Session 5 2:25-3:55 PM

2. Sautéing the Taxation of Deferred Compensation, Stock Options, and Executive Pay Lori Wolfe Compliance Manger Paylocity Email: lwolfe@paylocity.com 21st Annual IL Statewide APA Conference – August 21-22, 2014 Lauren VanDeveer Payroll Analyst Paylocity Email: lvandeveer@paylocity.com

3. Before we begin The recipe we’re creating has some specialty ingredients, so if you have questions… Please feel free to ask during the presentation… …or make note of them for follow up at the end.

4. Win Prizes Complete your recipe cards as we go along and help us choose some of the ingredients… And you could win prizes.

5. Let’s get trending! Include #APAStatewide2014 if you post online about our presentation, and you could win prizes.

6. A Taste of What’s to Come Deferred Compensation Qualified Nonqualified Stocks and stock options Employee stock ownership plans Stock as compensation Statutory stock options Nonstatutory stock options Executive Pay and Perks

7. Recipe for Success: Be a smart shopper and prepare the ingredients properly.

8. Selecting Ingredients Varieties of Deferred Compensation Plans Qualified Deferred Compensation Tastes like… 401(k) 403(b) 408(k) 457 501(c) 408(p)

9. Selecting Ingredients Varieties of Deferred Compensation Plans Qualified Deferred Compensation Found in the Produce section of our grocery store Subject to nondiscrimination requirements and specific wage and contribution limits Funds invested with investment firms Compliance generally monitored by investment firms annually Spoiling results in losing the tax exempt status

10. Selecting Ingredients Varieties of Deferred Compensation Plans Qualified Deferred Compensation How to identify spoiled product Fails ADP (actual deferral percentage) or ACP (actual contribution percentage) tests for nondiscrimination

11. Preparing Ingredients How to Tax Deferred Compensation Plans Qualified Deferred Compensation Deferrals Subject to social security, Medicare, and FUTA tax Generally exempt from federal income tax withholding ROTH contributions taxed at deferral Income Employer not responsible for distributions from plan upon retirement Generally subject to federal income tax withholding at time of distribution (except ROTH funds)

12. Selecting Ingredients Varieties of Deferred Compensation Plans Nonqualified Deferred Compensation Tastes like… 457(f) plans Stock options where exercise price is below fair market value on the date of grant Some split-dollar life insurance arrangements 409A plans

13. Selecting Ingredients Varieties of Deferred Compensation Plans Nonqualified Deferred Compensation Found in canned goods section Employee has rights to compensation that is payable in a later year Not subject to nondiscrimination requirements May be funded or unfunded Employer responsible for issuing payment for deferred income

14. Selecting Ingredients Varieties of Deferred Compensation Plans Nonqualified Deferred Compensation What it’s not: A qualified 401(a), 401(k), 403(a), 403(b); 457(b); SEP, SIMPLE, or 501(c)(18) retirement plan Any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan An Archer MSA, HSA, HRA, or other medical expense reimbursement plan that satisfied IRC 105 and 106

15. Selecting Ingredients Varieties of Deferred Compensation Plans Nonqualified Deferred Compensation How to identify spoiled product Deferred amounts are distributed earlier than restrictions allow Employer funds plan for top five officers while other financial circumstances are insecure

16. Preparing Ingredients How to Tax Deferred Compensation Plan Amounts Nonqualified Deferred Compensation Taxing deferred amounts Income tax Funded plan contributions subject to income tax when funds are set aside Unfunded plan not subject to income tax until payments are issued to employee Social security, Medicare, and FUTA tax calculated when amounts are deferred

17. Preparing Ingredients How to Tax Deferred Compensation Plan Amounts Nonqualified Deferred Compensation Calculating deferrals Account balance plans Nonaccount balance plans Stock rights Other deferred amounts

18. Preparing Ingredients How to Tax Deferred Compensation Plan Amounts Nonqualified Deferred Compensation Taxing income amounts To calculate income tax withholdings, treat amounts required to be included in income as supplemental wages Income from nonqualified deferred compensation is not subject to social security, Medicare, and FUTA tax, as this was calculated at the time of deferral

19. Preparing Ingredients How to Tax Deferred Compensation Plan Amounts Nonqualified Deferred Compensation When to withhold and pay taxes on includible income Amounts actually paid to employee during the year Considered wages paid on the date received by the employee Tax deposits and returns are due accordingly

20. Preparing Ingredients How to Tax Deferred Compensation Plan Amounts Nonqualified Deferred Compensation When to withhold and pay taxes on includible income Amounts not actually or constructively paid during the year Considered wages paid on December 31 Tax deposits must be paid by the due date of 4 th quarter Form 941

21. Preparing Ingredients How to Report Deferred Compensation Plan Amounts Nonqualified Deferred Compensation Reporting Deferrals Income tax reporting Unfunded plan deferrals (employer contributions) not reported on Form 941, W-2, or 1099-MISC Funded plan deferrals generally reported in Box 1 of Form W-2 and in Box 11 as taxable income from a nonqualified plan Social security, Medicare, and FUTA tax reporting When “taken into account,” deferred amounts are reported in Box 3 and 5 of Form W-2 If any deferred amounts taken into account are from prior years, also report in Box 11 of Form W-2

22. Preparing Ingredients How to Report Deferred Compensation Plan Amounts Nonqualified Deferred Compensation Reporting Distributions from Plan Social security, Medicare, and FUTA tax Not subject to tax at distribution Income tax Report amounts not taxed at time of deferral on Line 2 of Form 941 and in Box 1 of Form W-2 Report amounts currently includible in gross income from all years’ deferrals (plus earnings on those amounts) in Box 12 of Form W-2 with Code Z Report amounts includible in gross income for independent contractors in Boxes 7 and 15b of Form 1099-MISC

23. Preparing Ingredients How to Report Deferred Compensation Plan Amounts Nonqualified Deferred Compensation Form SSA-131, Employer Report of Special Wage Payments Used to report total amount employee earned during the tax year Normally the amount in Box 1 of Form W-2 less payments from a nonqualified plan, but including amounts deferred under the plan during the year Do not file if contributions and distributions occur in the same year and the employee will not be age 62 or older by the end of that year

24. Selecting Ingredients Varieties of Stocks and Stock Options Plans Employee Stock Ownership Plans Tastes like… Stock bonus plan Combined stock bonus and money purchase plan

25. Selecting Ingredients Varieties of Stocks and Stock Options Plans Employee Stock Ownership Plans Must meet general requirements under IRC §401(a) for participation, vesting, nondiscrimination, etc. Two types of funding: Nonleveraged – plan buys stock with funds provided by employer Leveraged – plan buys stock with borrowed funds

26. Preparing Ingredients How to Tax Stocks and Stock Options Plans Employee Stock Ownership Plans Employer contributions to qualified ESOP Are not wages Are not subject to federal income tax withholding or social security, Medicare, or FUTA tax May not exceed 100% of employee’s annual compensation and no more than $52,000

27. Selecting Ingredients Varieties of Stocks and Stock Options Plans Employer Stock as Compensation Tastes like… Compensation for services rendered Compensation in the form of stock as opposed to cash wages

28. Preparing Ingredients How to Tax Stocks and Stock Options Plans Employer Stock as Compensation Fair market value of stock when transferred to employee is subject to federal income tax and social security, Medicare, and FUTA tax Example: Employee is paid $500 regular wages and $500 in stock Federal income tax withholding and social security, Medicare, and FUTA tax are calculated on $1,000 and withheld from regular wages.

29. Preparing Ingredients How to Tax Stocks and Stock Options Plans Employer Stock as Compensation When stock is no longer subject to substantial risk of forfeiture, value above amount already taxed is included in recipient’s gross income Substantial risk of forfeiture is defined as a contingency that exists on the receipt of future compensation, which could prevent the transfer of said compensation Fair market value when transferred to employee  Amount paid for stock by employer Compensation subject to tax for recipient

30. Selecting Ingredients Varieties of Stocks and Stock Options Plans Statutory Stock Options Tastes like… Incentive stock options (ISO) Employee stock purchase plans (ESPP)

31. Selecting Ingredients Varieties of Stocks and Stock Options Plans Statutory Stock Options Terminology Grant date is the date on which an employee receives a stock option Exercise date is the date the stock will be purchased Option date is the date payment is made to secure the purchase of stock The value of the stock on each of these dates is pertinent

32. Selecting Ingredients Varieties of Stocks and Stock Options Plans Statutory Stock Options Incentive stock options Employees have opportunity to buy employer corporation’s stock at a fixed price for a certain period of time Not subject to income tax withholding and no income recognized until stock is sold if conditions are met

33. Selecting Ingredients Varieties of Stocks and Stock Options Plans Statutory Stock Options Employee stock purchase plans Employees have opportunity to buy employer corporation’s stock at a discount Not subject to rules as strict as ISOs

34. Preparing Ingredients How to Tax Stocks and Stock Options Plans Statutory Stock Options No employment taxes upon exercise or sale Not considered wages because post tax dollars used to purchase – no different than purchasing stock from a broker No W-2 reporting required

35. Preparing Ingredients How to Tax Stocks and Stock Options Plans Statutory Stock Options Report stock option activity when corporation transfers legal title to stock ISO activity reported on Form 3921, Exercise of an Incentive Stock Option Under Section 422(b) ESPP activity reported on Form 3922, Transfer of Stock Acquired Through and Employee Stock Purchase Plan Under Section 423(c) Taxed at capital gain rate when stock is sold

36. Selecting Ingredients Varieties of Stocks and Stock Options Plans Nonstatutory Stock Options Tastes like… Option for employee to buy employer corporation’s stock at a fixed price for a certain period of time, without conditions placed on ISOs Taxable income = Value of stock when option exercised – price paid by the employee

37. Preparing Ingredients How to Tax Stocks and Stock Options Plans Nonstatutory Stock Options Income subject to federal income tax withholding and social security, Medicare, and FUTA taxes at time of exercise Report in Boxes 1, 3, and 5 of Form W-2 and include in Box 12 preceded by Code V

38. Selecting Ingredients Varieties of Executive Pay and Perks Executive Pay and Perks Tastes like… Golden parachute pay Club dues Personal Use of Co Vehicle Personal use of Co Aircraft Restricted Stock Severance Agreement Financial Counseling Spouse Travel GTL over $50

39. Preparing Ingredients How to Tax Executive Pay and Perks Executive Pay and Perks Golden parachute pay Issued to key executives when company ownership changes Used to “soften landing” if employment is terminated under new ownership Payment is at least three times employee’s average annual compensation over last five years

40. Preparing Ingredients How to Tax Executive Pay and Perks Executive Pay and Perks Golden parachute pay Entire payment subject to federal income tax withholding and social security, Medicare, and FUTA tax on entire amount Portion of payment in excess of employee’s five-year average subject to additional 20% excise tax Report excise tax in Box 12 of Form W-2, preceded by Code K

41. Preparing Ingredients How to Tax Executive Pay and Perks Executive Pay and Perks Club dues Not taxed if substantiated for business use No reporting required

42. Selecting Ingredients Varieties of Executive Pay and Perks Executive Pay and Perks Miscellaneous executive perks treated same for executives as non- executives: Personal Use of Co Vehicle Personal use of Co Aircraft Restricted Stock Severance Agreement Financial Counseling Spouse Travel GTL over $50

43. Still have questions? Feel free to send us an email at lwolfe@paylocity.com or lvandeveer@paylocity.com.

44. Thank You for Attending! 21st Annual IL Statewide APA Conference – August 21-22, 2014