Owners of many businesses, both large and small, often want to provide for themselves or certain of their key employees. However, money is not always readily available, and businesses are not always capable of sustaining a gratuitous disposition of stock. Moreover, making such distributions can result in a much higher amount of taxable income for the individual, the business, or both. For these reasons, a Deferred Compensation Plan or Agreement may be just the right fit.
Business owners and employers know the value of keeping their key employees happy, and one way to keep someone happy is to give them more money. If the business has enough assets and no real future need for the excess capital, then paying out bonuses or raising salaries is a quick and easy option. Another more traditional method was to provide the key employees with stock or stock options, but giving an individual stock in the business makes them a part owner in the operation.
Deferred Compensation is a tool to keep key employees happy by giving them the opportunity to accrue bonus pay or stock options without having to give it to them right now. By waiting, the business can have more time to accumulate the capital needed to pay the bonus or delay the point in time that a key employee becomes an owner of the business. Most importantly, deferment may provide the recipient with the ability to lessen their taxable income and therein make more money off the same bonus. In other words, Deferred Compensation has the potential to be worth more money than ordinary compensation.
For example, in 2001 the highest tax rate was 39.1%, in 2005 that rate was 37.6%, and by 2010 the tax rate will be 35%. If a business wanted to pay a key employee a $100,000 bonus in 2001, that employee’s net after tax return on that bonus would be about $61,000. If the employee then invested in some bonds that paid 4.5%, by 2005 they would have about $72,750, and by 2010 they would have about $90,660. That is not bad, but Deferred Compensation can do better.
Assuming that the same interest rate is applied to the money and it is deferred in payment until 2005, the individual would now receive $74,410, a difference of about $1,500. By 2010, money that was deferred until 2005 would be worth $92,730. Finally, if the compensation is deferred until 2010 the individual would receive about $96,600, nearly $6,000 more than if it were paid in 2001 and $4,000 more than if paid in 2005. These numbers are by no means guaranteed to be the maximum or the minimum return, but they can illustrate the possible advantages to Deferred Compensation.
Many small businesses and companies that are just starting up do not have the capital to pay cash bonuses. Deferred Compensation Plans may be used to create stock ownership, or, if the business is being built for its eventual sale, Deferred Compensation may be used to give key employees a chance to receive a percentage of the profits from a sale of the business. Plans that give an employee a share in the profits from the sale of the company can ensure that the business does not ever have to expend its own funds, as the only funds expended are derived from the profits from the sale of the company. In addition, the key employee, having a stake in the business, is truly motivated to ensure that the business is built up to be the very best it can be. After all, the more money the business sells for, the more money a key employee with such a Deferred Compensation Plan is bound to make.
If our clients request that we prepare a Deferred Compensation Plan and Agreement for their business, we at Gabriel Law Office, PLLC work hard to create a plan that is carefully designed to meet the needs of our clients and their business. Contact us to discuss how a Deferred Compensation Plan and Agreement can benefit your business and your employees.