CEBS Executive Compensation & Nonqualified Plans 2 — Questions and Answers
Question 1: An Incentive Stock Option (ISO) differs from a Nonstatutory Stock Option (NSO) primarily in that:
- ISOs must be exercised within 10 years and may generate preferential AMT treatment (Correct answer)
- NSOs are only available to executives who own more than 10% of company stock
- ISOs trigger ordinary income tax at the date of grant
- NSOs are exempt from Section 409A compliance requirements
Correct answer: ISOs must be exercised within 10 years and may generate preferential AMT treatment
ISOs receive preferential tax treatment—no ordinary income tax at exercise—but the spread at exercise is an AMT preference item and must meet strict holding period requirements.
Question 2: Restricted Stock Units (RSUs) are generally taxed to the executive at:
- The date of grant, based on the stock's fair market value
- The date of vesting, as ordinary income on the fair market value of shares delivered (Correct answer)
- The date of sale, as long-term capital gain
- The date the employer makes a Section 83(b) election
Correct answer: The date of vesting, as ordinary income on the fair market value of shares delivered
RSUs are taxed as ordinary income at vesting when the shares are actually delivered to the executive, since there is no property transferred at grant for a Section 83(b) election.
Question 3: A phantom stock plan provides executives with:
- Actual shares of company stock held in escrow
- A cash or stock payment equal to the value of a specified number of hypothetical shares (Correct answer)
- An option to purchase stock at a discount to fair market value
- Preferred stock with guaranteed dividends
Correct answer: A cash or stock payment equal to the value of a specified number of hypothetical shares
Phantom stock plans credit executives with hypothetical share units that track the company's stock price, paying out cash or actual shares based on the appreciated value without issuing real equity.
Question 4: Stock Appreciation Rights (SARs) granted to an executive pay out:
- The full fair market value of the stock at the exercise date
- Only the increase in stock value from the grant date to the exercise date (Correct answer)
- A fixed dollar amount set at the time of grant
- Dividends declared on the underlying shares during the holding period
Correct answer: Only the increase in stock value from the grant date to the exercise date
SARs pay only the appreciation in stock value (the spread between grant price and exercise price), allowing executives to participate in stock growth without investing their own capital.
Question 5: Section 280G of the Internal Revenue Code imposes an excise tax on 'excess parachute payments' made to executives. This provision is triggered when payments contingent on a change in control exceed:
- $1 million in total compensation for the year
- Three times the executive's average annual compensation over the prior five years (Correct answer)
- Two times the executive's base salary at the time of the transaction
- The Section 415 defined benefit limit for the year
Correct answer: Three times the executive's average annual compensation over the prior five years
Section 280G applies when total change-in-control payments equal or exceed three times the executive's base amount (average W-2 compensation for the prior five years), and imposes a 20% excise tax on the excess.
Question 6: An 'excess benefit plan' under ERISA is a nonqualified plan established to:
- Provide medical benefits beyond the ACA minimum essential coverage standards
- Restore qualified plan benefits limited by Section 415 or Section 401(a)(17) caps (Correct answer)
- Offer supplemental disability income above 60% of salary
- Fund post-retirement health benefits for active executives
Correct answer: Restore qualified plan benefits limited by Section 415 or Section 401(a)(17) caps
An excess benefit plan is a top-hat plan that provides the benefit an executive would have received under the qualified plan but for the IRS limitations on contributions and benefits.
Question 7: The 'constructive receipt' doctrine requires an executive to include deferred compensation in income when:
- The employer formally funds the plan with an irrevocable contribution
- Amounts are set aside and made available to the executive without substantial limitation (Correct answer)
- The executive reaches age 59½ and becomes eligible for early distributions
- The employer files Form W-2 reporting the deferred amounts
Correct answer: Amounts are set aside and made available to the executive without substantial limitation
Constructive receipt occurs when compensation is credited to an executive's account or made available without a substantial limitation or restriction, even if not actually received.
CEBS Executive Compensation & Nonqualified Plans 2
An Incentive Stock Option (ISO) differs from a Nonstatutory Stock Option (NSO) primarily in that: