CCP Incentive Compensation 2 — Questions and Answers
Question 1: A company wants to reduce windfall payouts during unusually high market cycles. Which plan design feature best addresses this?
- Cliff vesting schedule
- Performance cap or maximum payout limit (Correct answer)
- Relative TSR modifier
- Lookback provision
Correct answer: Performance cap or maximum payout limit
A maximum payout cap limits incentive payouts to a defined ceiling, preventing windfalls during atypical high-performance periods.
Question 2: Under a nonqualified deferred compensation plan subject to IRC Section 409A, when must a participant make an initial deferral election?
- Within 30 days after the plan year ends
- Before the beginning of the year in which services are performed (Correct answer)
- Within 60 days of plan enrollment
- At any time with 30-day notice to the employer
Correct answer: Before the beginning of the year in which services are performed
IRC Section 409A generally requires deferral elections to be made before the start of the taxable year in which the services are rendered.
Question 3: Which metric is most commonly used in relative Total Shareholder Return (TSR) plans to determine payout?
- Percentile rank vs. peer group (Correct answer)
- Absolute stock price appreciation
- EBITDA growth rate
- Revenue per employee
Correct answer: Percentile rank vs. peer group
Relative TSR plans compare the company's shareholder return to a peer group, ranking performance at a specific percentile to determine award payouts.
Question 4: An employee receives a $10,000 cash bonus. Under FICA rules, how is this supplemental wage payment treated?
- Exempt from FICA if paid as a bonus
- Subject to FICA taxes at the same rate as regular wages (Correct answer)
- Subject only to Medicare tax, not Social Security
- Withheld at a flat 22% federal rate with no FICA
Correct answer: Subject to FICA taxes at the same rate as regular wages
Bonus payments are supplemental wages and are subject to FICA (Social Security and Medicare) taxes just like regular wages.
Question 5: A sales incentive plan pays reps 5% commission on revenue up to quota and 8% on revenue above quota. This structure is known as:
- Flat rate commission
- Accelerated commission schedule (Correct answer)
- Draw against commission
- Decelerating commission plan
Correct answer: Accelerated commission schedule
An accelerated commission schedule increases the payout rate once a threshold (quota) is exceeded, motivating above-target performance.
Question 6: Which of the following best describes a phantom stock plan?
- A plan granting actual shares at a discount
- A cash-settled plan that mimics stock appreciation without issuing real shares (Correct answer)
- A restricted stock unit plan with a market condition vesting trigger
- A leveraged ESOP funded with employer debt
Correct answer: A cash-settled plan that mimics stock appreciation without issuing real shares
Phantom stock plans provide cash payments tied to stock value movements without granting actual equity, making them useful for private companies.
Question 7: When designing an annual incentive plan, which approach ensures the performance goals remain challenging yet achievable?
- Setting targets at the 90th percentile of historical performance
- Calibrating targets to a 50–60% probability of achievement (Correct answer)
- Using prior-year actual results as the target each year
- Setting targets at maximum theoretical capacity
Correct answer: Calibrating targets to a 50–60% probability of achievement
Best practice calibrates annual incentive targets so there is roughly a 50–60% chance of achieving them, balancing stretch with realism.
CCP Incentive Compensation 2
A company wants to reduce windfall payouts during unusually high market cycles.
Which plan design feature best addresses this?