RFC Business Planning & Owner Strategies 2 — Questions and Answers
Question 1: Key person life insurance purchased by a business to protect against the loss of a critical employee is owned by and payable to whom?
- The key employee and their named beneficiary
- The business entity (Correct answer)
- A trust established by the key employee
- The key employee's surviving spouse
Correct answer: The business entity
The business owns and is the beneficiary of key person life insurance, using the proceeds to offset financial losses resulting from the key employee's death.
Question 2: In a nonqualified deferred compensation plan using a 'rabbi trust,' an executive's deferred benefits are:
- Fully shielded from the employer's creditors in all circumstances
- Subject to claims of the employer's general creditors in bankruptcy (Correct answer)
- Immediately taxable to the executive when contributed to the trust
- Guaranteed by a federal insurance program similar to PBGC
Correct answer: Subject to claims of the employer's general creditors in bankruptcy
A rabbi trust is an unsecured arrangement; while assets are held outside the employer's direct control, they remain reachable by the employer's general creditors in insolvency.
Question 3: Under IRC Section 409A, which of the following is NOT a permissible distribution trigger for a nonqualified deferred compensation plan?
- Separation from service
- Change in control of the employer
- The executive's voluntary request at any time (Correct answer)
- Death or disability
Correct answer: The executive's voluntary request at any time
Section 409A prohibits accelerated or discretionary distributions; elections and timing must be fixed in advance at specified permissible events.
Question 4: Under a split-dollar life insurance arrangement, which feature makes it attractive as an executive benefit?
- Premium costs are always tax-deductible by the employer
- The employer can recover its premium outlay from the policy's cash value or death benefit (Correct answer)
- The employee receives current income tax-free death benefit protection with no reportable income
- It qualifies as a defined benefit plan under ERISA
Correct answer: The employer can recover its premium outlay from the policy's cash value or death benefit
Split-dollar allows the employer to recoup its premium investment while providing the executive with death benefit protection, making it cost-efficient for the employer.
Question 5: An executive receives incentive stock options (ISOs). At the time of exercise, the tax consequence for regular income tax purposes is:
- Ordinary income equal to the entire spread between exercise price and FMV
- No regular income tax is recognized, though the spread may be an AMT preference item (Correct answer)
- Capital gains tax is triggered immediately
- The employer receives a compensation deduction equal to the spread
Correct answer: No regular income tax is recognized, though the spread may be an AMT preference item
ISOs generate no regular income tax at exercise; however, the bargain element is an adjustment for alternative minimum tax (AMT) purposes.
Question 6: A 'golden parachute' payment triggers a 20% excise tax under IRC Section 4999 when it equals or exceeds what threshold?
- 1 times the executive's average annual compensation
- 2 times the executive's average annual compensation
- 3 times the executive's average annual compensation (Correct answer)
- 5 times the executive's average annual compensation
Correct answer: 3 times the executive's average annual compensation
Payments are 'excess parachute payments' subject to excise tax when the total equals or exceeds three times the executive's average annual compensation base amount.
Question 7: Which of the following best describes a Supplemental Executive Retirement Plan (SERP)?
- A qualified defined benefit plan subject to ERISA funding requirements
- A nonqualified promise by the employer to pay a supplemental retirement benefit, typically to selected executives (Correct answer)
- A government-sponsored retirement program for corporate executives
- An IRA-based plan with higher contribution limits for high-income earners
Correct answer: A nonqualified promise by the employer to pay a supplemental retirement benefit, typically to selected executives
A SERP is an unfunded, nonqualified arrangement in which the employer promises selected executives additional retirement income beyond qualified plan limits.
RFC Business Planning & Owner Strategies 2
Key person life insurance purchased by a business to protect against the loss of a critical employee is owned by and payable to whom?