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he would have spent anyway. In fact, his economic position is enhanced, since he pays no taxes on the
salary he does not receive, as well as escaping from the limitations on deductibility described earlier.
The corporation pays out no more money this way than it would have if the entire amount were
salary. Taxwise, the corporation is only slightly worse off, since the amount it would have previously
deducted as salary can now still be deducted as ordinary and necessary business expenses (with the
sole exception of the limit on meals and entertainment). In fact, were Brad‟s salary below the Social
Security contribution limit (FICA), both Brad and the corporation would be better off, because what
was formerly salary (and thus subject to additional 7.65% contributions to FICA by both employer and
employee) would now be merely business expenses and exempt from FICA.
Before Brad and Morris adopt this strategy, however, they should be aware that in recent years
Congress has turned a sympathetic ear to the frustration the IRS has expressed about expense
accounts. Legislation has conditioned the exclusion of amounts paid to an employee as expense
reimbursements upon the submission by the employee to the employer of reliable documentation of
such expenses. Brad should get into the habit of keeping a diary of such expenses for tax purposes.
Deferred Compensation
Often, high-level executives negotiate salaries and bonuses that far exceed their current needs. In such
a case, the executive might consider deferring some of that compensation until future years. Brad may
feel, for example, that he would be well advised to provide for a steady income during his retirement
years, derived from his earnings while an executive of Plant Supply. He may be concerned that he
would simply waste the excess compensation and may consider a deferred package as a form of forced
savings. Or he may wish to defer receipt of the excess money to a time (such as retirement) when he
believes he will be in a lower tax bracket. This latter consideration was more common when the
federal income tax law encompassed a large number of tax brackets and the highest rates were as high
as 70%.
Whatever Brad‟s reasons for considering a deferral of some of his salary, he should be aware that
deferred compensation packages are generally classified as one of two varieties for federal income tax
purposes. The first such category is the qualified deferred compensation plan, such as the pension,
profit-sharing, or stock bonus plan. All these plans share a number of characteristics. First and
foremost, they afford taxpayers the best of all possible worlds by granting the employer a deduction
for monies contributed to the plan each year, allowing those contributions to be invested and to earn
additional monies without the payment of current taxes, and taxing the employee only upon
withdrawal of funds in the future. However, in order to qualify for such favorable treatment, these
plans must conform to a bewildering array of conditions imposed by both the Internal Revenue Code
and the Employee Retirement Income Security Act (ERISA). Among these requirements is the
necessity to treat all employees of the corporation on a nondiscriminatory basis with respect to the
plan, thus rendering qualified plans a poor technique for supplementing a compensation package for a
highly paid executive.
The second category is nonqualified plans. These come in as many varieties as there are employees
with imaginations, but they all share the same disfavored tax treatment. The employer is entitled to its
deduction only when the employee pays tax on the money, and if money is contributed to such a plan