IRC401

MBozek- If the "option" is really NQDC, it is taxable to the employee of the for-profit entity under the doctrine of constructive receipt and to the employee of the non-profit under 457(f). That is the difference. PJK- 1. Start looking more at the economics and less at the regs and case law. If the employer allows for a cashless exercise (which as far as I know they all do), the fees related to the exercise can be deducted from the proceeds. [PS: I have been told that E&Y doesn't even bother with the formalities of an option exercise.] 2. If an employer tells an employee that he can take his NQDC whenever he wants it at anytime during the next ten years, when is the employee taxed. When (and if) he takes it or as of the first day that he could take it??? 3. ERISA is not voluntary. Regardless of whether the employer wants to make these "options" subject to ERISA, it has no say in the matter.

Sorry to change the topic somewhat, but PJK's response deserves a reply. The LoBue and Graney cases deal with fixed price options and therefore are not relevant. My criticism is of variable price options. Technically, all four cases deal with fixed price options. The issue is whether the amount of the discount is so great as to make the arrangement not an option. The Victorson case appears to take the position that anything that is called an option is an option (and if that is the correct interpretation the entire tax bar and all tax CPAs have been negligent for decades for missing a golden opportunity to ignore the doctrince of contructive receipt). The case could also be interpreted to mean that a taxpayer is bound by his choice of form, but the IRS is not (which produces a very different result). You are probably already aware of the comment in the Veal and Brisendine article noted above that it would not be prudent to rely on the case. I have no specific comment on the fourth case at the moment. I should also note that the Veal and Brisendine article discusses fixed price options. They tiptoe around variable price options. If you think that that article supposrts variable price options, read it again very carefully. I don't know what the IRS is up to. If the Service wants to kill 90%+ of the discounted options out there, it could do so with a revenue ruling invoking the doctrines that I listed above. It could also kill all of them by amending the 83 regs, which would take more time. If it goes at them using the 457(f) regs, it seem to me that once again the IRS has decided to do things the hard way with the least chance of success.

I just want to make my position clear. The reason why most discounted options should be immediately taxable upon grant (or vesting) has nothing to do with section 83. The options fail under the sham transaction, economic substance, and substance over form doctrines. If anyone has an opinion letter explaing why an option with a floating exercise price survives these doctrines, I would love to see it. NOTE: I didn't state that you couldn't design an option that survives under these doctrines; I'm merely stating that most so-called discounted options don't survive when scrutinized. If Congress is going to allow these "options" to survive, it should repeal the doctrine of construcitve receipt because there is no good policy reason why certain people, by going through some paperwork with no economic substance should be able to get around the doctrine.

So, if you have a company in which the owners, the directors, and the senior officers are all the same people (or are members of the same family), and if they don't want to pay a bank or trust company to act as trustee, does it hurt to name the corporation as trustee? (assuming that it is legal to do so under state law)

I agree that it is a matter of state law. I believe that PA law allows a corporation to be trustee of its own benefit plans. I do not know if there is any other state that so allows.

The answer to your question depends on facts not readily available to readers on the message board. Before answering the question, I would want to read the LTD policy and have a complete understanding of the individual's current position and compensation package.

PA taxes salary reductions for dependent care but not for medical benefits.

See 1.401(k)-1(g)(5), which sends you to 1.410(B)-9. "Employee means an individual who performs services for the employer..."

I thought that only employees could make 401(k) elections and don't recall anything in the Code or regs that includes former employees as employees.

As far as I know if you want to have an age-weighted formula, you need to use a custom document. I understand that some consultants have prototype documents that allow for age-weighted formulas, but having an age-weighted fomula converts the document into a custom document in the eyes of the IRS. As for your history question, once upon a time I got an IRS determination letter for a volume submitter 401(k)/ profit-sharing document with an age-weighted allocation formula. Apparently I got my letter before the IRS made its policy. The IRS agent told me that I was lucky and the letter was good but refused to issue a letter for a volume submitter profit-sharing plan (with an age-weighted formula) without the 401(k) feature. I am not aware of anyone else ever getting a determination letter for a volume submitter or prototype plan with an age-weighted formula (which doesn't mean that it didn't happen), and my document became obsolete several tax laws ago.

The plan document should specify who is eligible to participate (which may be hard to do with a prototype document under your facts and circumstances). The union and non-union portions of the plan are disaggregated for purposes of testing (which wouldn't be an issue if all participants are non-HCEs).

Could an employer achieve virtually the same result as hedging by buying ETFs, instead of mutual funds, to "fund" the NQDC plan? [There would need to be ETFs that are economically similar to the investment options in the NQDC plan.]

PA taxes 401(k) and 403(B) elective deferral contributions. It does not tax 125 salary reductions for medical care but does tax 125 salary reductions for dependent care. I am not aware of any other states that tax 401(k) contributions (for reasons not related to EGTRRA). Last time I checked there were municipalities in Ohio that taxed them and (if my memory is correct) some transit authority in Oregon. [ I do not pretend to have any expertise re: Orgeon tax rules.]

Could the IRS make the argument that the charge for taking a distribution s so high that some participants don't have a meaningful right to elect to take a distribution, and therefore, the requirements of IRC 404(k) aren't met, and the deduction is disallowed.

If anyone is interested in facts about the Enron DB/ESOP offset arrangement, see DoL Advisory Opinion 94-42A.

AndyH- If it will make you feel any better, I had a plan that failed the nondiscriminatory classification test by 5/10,000 ths of an employee.

I would also like to add that the basis for taxing employees with discounted options is the doctrine of constructive receipt, which is a judicial doctrine. All that it takes for the taxpayers to lose is for the courts to hold that a taxpayer can't get around the doctrine of constructive receipt by papering over an otherwise taxable event with a transaction that has no economic significance. To me that is not such a far fetched outcome. (Of course, whether the IRS will ever get around to bringing an enforcement action is a different matter.)

MBozek- You and Carol missed the point of my comments. If what is being sold is in fact an option, it works. My argument is that the product is not an option (within the meaning of section 83). There is a Black Scholes value if the option has a fixed price. What is being sold has a variable price. What is the Black Scholes value of an "option" to purchase 100 shares of the Vanguard S&P 500 fund for the price that Vanguard will sell the fund to anyone who wants to buy it? The answer is zero. Is giving someone the "option" to buy a readily available product at the full retail price really an option within the meaning of section 83? If an employer gives an employee the "option" to take his NQDC in form of 5000 shares in a Vanguard fund whenever he wants them, is the employee taxable when he "exercises" or when he has constructive receipt? IMHO, when he has contructive receipt. If an employer gives an employee the "option" to buy 5000 shares of a Vanguard fund at the full retail price (determined as of the date of sale), has the employer granted an "option" within the meaning of section 83? Now combine the two. The employee is given an "option" to buy 10000 shares (instead of 5000 shares) for a price equal to 5000 shares on the date of exercise (not grant). The value of the discount is the value of 5000 shares. The Black Scholes value is zero because the employee's exercise price fluctuates. All that the employer has done is put a wrapper with no economic significance around NQDC that would otherwise be taxable under the doctrine of constructive receipt. [Note: The options allow for cashless exercise. Therefore, when the employee "exercises" all he does is take his NQDC equal to the value of 5000 Vanguard shares when he wants them.] If this product is in fact an option, then people have found a way for wealthy taxpayers to avoid the doctrine of contructive receipt purely by the form of the transaction. I don't think that it works. NOTE: If the employer had granted the employee an option to purchase 10,000 shares for a fixed price equal to the price of 5000 shares on the date of grant, there would be a real option. The problem with fixed price options is that either the employer or employee has to absorb the Black Scholes value. The advantage of floating price options is that there is no messy Black Scholes value to deal with. When you design a tax product with no economic substance, how often does it work ? PS: 1. Most of the actual products being sold have more smoke and mirrors than described above, but no more economic substance. 2. If you believe that form governs, how about an option to purchase shares of a money market fund? (Bank CDs?) Is an option to take cash, really an option? If no, then there have to be some applicable rules not in the 83 regs.

I was referring to the BS value at the date of grant. Suppose that an employee is given an option to purchase shares of ABC mutual fund, which to make the arithmetic easy, is selling for $1 per share. If he is given an option to buy 10,000 shares for $5000, that is a classic option, which is worth the $5000 discount plus the value of the opportunity for appreciation on 10,000 shares. Suppose instead that he is given an "option" to buy 10,000 shares for the price of 5000 shares. The price of his option floats with the price of the shares so that the employee is always able to get 10,000 shares for the price of 5000. The value of the option on the date of grant is the value of 5000 shares. The value of the option privilege or the BS value is $0. How is that "option" economically distinquishable from an unfunded promise to pay 5000 shares on the date of exercise? [Hint: It isn't.] If an employee were given an "option" to take 5000 shares of ABC fund, wouldn't he be taxable under the doctrine of constructive receipt as of the first day that he could exercise (and maybe faster under 457(f))? Therefore, the issue becomes whether if you take something that is taxable under the doctrine of constructive receipt (or 457(f)) and put a wrapper or disquise around it that has no economic substance, are you suddenly able to fall under the section 83 rules? In practice, D&T, E&Y, and (I assume)KPMG are selling slightly different variations. Suppose that the exercise price is the greater of $5000 or 50% of the value of 10,000 shares. If the price of the fund increases, the option price is the price of 5000 shares and the product becomes identical to the dubious "option" described above. If the price of ABC fund drops, the price of the "option" is fixed at $5000, which means that once you remove the discount at grant from the calculation, the employer is granting an "option" at a higher price than the employee could get by calling the ABC Fund and buying directly. Such an "option" couldn't (and doesn't) exist outside of the world of deferred compensation. As for the option (section 83) regs, I thought that they predated Black Scholes and Merton's work and that they were designed to delay the taxation of options in order to avoid valuation fights back in the days when no one knew how to value options. Keep in mind that the discounted options that I have been discussing aren't designed to be options. They are deferred compensation plans that are disguised as options in order to get favorable tax treatment.

There is related discussion on this topic on the NQDC message board. The major issue with most discounted option products is whether they are in fact options for purposes of section 83. If the value of the option privilege (the "Black-Scholes" value) is zero or negative (which is usually the case), the "option" has no economic substance. [Does putting the word "option" on a sheet of paper and telling someone that he has the "option" to take his deferred comp. when he wants to, create an option? The product could not exist but for the tax benefits.] If you believe that form governs over substance, the products work. If you believe that there needs to be some substance, be careful.

My vote is that the payments are reportable as wages and subject to withholding by the Company because that is to whom the services were performed. The IRS will treat the arrangement as a capital contribution to the Company followed by a payment of deferred compensation. I assume that there will be an excise tax for self-dealing and that the Company, the executive, or the directors of the private foundation that approved the arrangement will be liable for refunding the money. I admit that I am not an expert with regard to private foundations. I strongly recommend that the private foundation get some competent legal counsel that specializes in private foundations because all of these issues (inlcuding the withholding and reproting) should have been dealt with when the arrangement was set up.

See PLR 8708031. The IRS appears to draw a distinction between borrowing money and buying on margin. There are other rulings out there, and I do not pretend to be up to date on the issues. My advice to pax is that if you are not willing to research the UBTI issues, don't do it.

US citizens working overseas have 415 income. Not only should expatriates be eligible to make 403(B) elective deferrals, but the employer may be required to permit them to make the contributions under 403(B)(12). PS: The foreign government may not recognize IRC 403(B) and may tax the elective deferrals.

A corporation is a separate legal entity. If the corporation paid $150,000 (for example) to John Doe last year, Mr. Doe is an HCE this year, regardless of changes in the ownership of the stock of the corporation (unless he isn't an HCE because of the 20% rule).

There may not be an annual use it or lose it provision, but what happens if the emplyee dies with money in the account? If there isn't some sort of use it or lose it provision, why isn't it a plan of deferred compensation?