Nonprofit Variable Pay

VARIABLE PAY AND BENEFITS

In addition to variable pay, executives are also often rewarded with increased benefits.

Benefits are membership rewards. As such, these rewards are available to the employee for being and staying a member of the organization and are not particularly related to performance.

This view of benefits is supported by government regulations that require that all employees be enrolled in certain benefit programs in order for the benefit program to be considered qualified. Organizations do not have to design their plans to meet government regulations, but then these plans are non-qualified. In non-qualified plans, the value of the benefit to the employee is taxed as income. Non-qualified plans are most common for top executives and will be discussed below.

Perquisites

Executives typically have more extensive benefit plans than other employees.

First, they often receive perquisites. These special benefits are designed to satisfy the special needs of this group.

There are three categories of perquisites:

• Internal. These perquisites consist of items that are part of the manager's work setting (such as special offices and furniture) that distinguish their status.
• External. This category has to do with conducting business outside of the organization, and may include a car, entertainment expenses, and club memberships.
• Personal. This category consists of a wide variety of items such as free medical examinations, additional vacation time, and financial or legal counseling.

Nonqualified Benefits

Executives receive benefits that are non-qualified as they are not available to all employees. As such, they are considered ordinary income to the executive and are not always a deductible expense for the organization. The majority of these plans involve deferred income. Thus, these plans are called nonqualified deferral plans (NQDPs).

Designing Nonqualified Deferral Plans

There are three aspects of US tax law that must be considered when designing an NQDP in order to avoid current income taxation for employees:

• constructive receipt
• economic benefit
• risk of forfeiture

Constructive receipt. Payments to an employee will be taxable as soon as the money is made available to that employee if there are no restrictions on the right to be paid.

Three key criteria must be met to avoid constructive receipt with respect to an NQDP such as a SERP:

1. The election to defer must be made before the compensation is earned.
2. There must be a substantial limitation or restriction over the receipt of the benefit. In nonprofits, the employee cannot receive the money until retirement, termination, disability, or death.
3. To successfully avoid constructive receipt in an NQDP, the plan must remain unfunded. In essence, the employee has an unsecured promise from the employer to pay the benefits and is put in the position of a general creditor.

Economic benefit. Any benefit granted to an individual must be included as compensation for income tax purposes in the year the benefit is granted. This would be true even if the employee didn't have a current right to receive the property in question. This can be avoided by having a substantial risk of forfeiture; thus, the requirement that the plan must remain "unfunded."

Risk of forfeiture. Both of the above design considerations emphasize that there needs to be a substantial risk of forfeiture in designing an NQPD. The best way to ensure that this criterion is met is to keep the plan unfunded. If there are assets in the plan, then these assets must be subject to the company's general creditors in case of bankruptcy.