In the United States, a Rabbi trust is a type of trust used by businesses or other entities to defer the taxability to the person or entity receiving (the payee) such payments as employee compensation or purchase payments in the acquisition of another business.
The first such trust set up was for the benefit of a rabbi, resulting in the name Rabbi Trust. [1] Revenue Procedure 92-64 further clarified the acceptable rules for Rabbi trusts along with a model trust document and the required features to avoid constructive receipt of income to the employee.[ citation needed ]
An example of a Rabbi trust applying where an employee receives compensation the taxation of which is deferrable is a nonqualified deferred compensation plan.
A Rabbi trust may be applicable when one business purchases another business but wants to set aside part of the purchase price and defer payment as well as taxability to the payee upon the satisfaction of conditions to which both parties agree.
A non-qualified deferred compensation plan is one under which current income of an employee is deferred and therefore not taxable to the employee. An employer sets aside assets in a separate trust for the employee in the future. Ordinarily, this would cause current inclusion into gross income even though the employer has yet to reduce the money to income because of the economic benefit theory doctrine. Funds deposited in such a plan permitted by a private letter ruling would not result in income, according to Section 83(a) of the Code, if the assets of the trust were available to the employer's general creditors. This is because until the employee is vested, that employee is under a substantial risk of forfeiture and under Section 83(a) and accompanying regulations 1.83-1 and as such is not subject to current inclusion into that employee's gross income.
All non-qualified deferred-compensation plans must involve substantial risk of forfeiture or other methods of avoiding constructive receipt, such as conditioning payment upon performance of future conditions or service. The unique feature of the Rabbi Trust is that the money placed into the trust is protected from changes of heart of the employer. Once placed in the trust, the money cannot be revoked by decisions made by the employer. As long as the employer's financial position is sound, the money in a Rabbi Trust is considered to be relatively safe. However, if an employer files for bankruptcy protection, the money may be subject to the claims made by that employer's general unsecured creditors.
When one business purchases another business, the purchasing business may want to set aside part of the purchase price and defer its payment to the payee upon the satisfaction of conditions to which both parties agree. A Rabbi trust may be used in this situation to defer the taxability to the payee of the deferred payments of the purchase price.
For the Rabbi trust to be successfully applied, there must be a real risk of forfeiture upon the failure by the payee to fulfill the agreed upon conditions. If the condition is impossible to fail, then constructive receipt may overcome the successful application of the Rabbi trust.
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The Rabbi trust allows the deferment of compensation whether employment income or the purchase price of a business acquisition, and the absence of this would result in the taxability to the payee of the compensation not yet received by the payee. This would serve as a disincentive for deferring such payments.
A trust is a legal relationship in which the owner of property gives it to another person or entity, who must manage and use the property solely for the benefit of another designated person. In the English common law, the party who entrusts the property is known as the "settlor", the party to whom it is entrusted is known as the "trustee", the party for whose benefit the property is entrusted is known as the "beneficiary", and the entrusted property is known as the "corpus" or "trust property". A testamentary trust is an irrevocable trust established and funded pursuant to the terms of a deceased person's will. An inter vivos trust is a trust created during the settlor's life.
In the United States, a 401(k) plan is an employer-sponsored, defined-contribution, personal pension (savings) account, as defined in subsection 401(k) of the U.S. Internal Revenue Code. Periodic employee contributions come directly out of their paychecks, and may be matched by the employer. This pre-tax option is what makes 401(k) plans attractive to employees, and many employers offer this option to their (full-time) workers. 401(k) payable is a general ledger account that contains the amount of 401(k) plan pension payments that an employer has an obligation to remit to a pension plan administrator. This account is classified as a payroll liability, since the amount owed should be paid within one year.
A pension is a fund into which amounts are paid regularly during an individual's working career, and from which periodic payments are made to support the person's retirement from work. A pension may be:
Employee stock options (ESO) is a label that refers to compensation contracts between an employer and an employee that carries some characteristics of financial options.
In law, vesting is the point in time when the rights and interests arising from legal ownership of a property are acquired by some person. Vesting creates an immediately secured right of present or future deployment. One has a vested right to an asset that cannot be taken away by any third party, even though one may not yet possess the asset. When the right, interest, or title to the present or future possession of a legal estate can be transferred to any other party, it is termed a vested interest.
The 457 plan is a type of nonqualified, tax advantaged deferred-compensation retirement plan that is available for governmental and certain nongovernmental employers in the United States. The employer provides the plan and the employee defers compensation into it on a pretax or after-tax (Roth) basis. For the most part, the plan operates similarly to a 401(k) or 403(b) plan with which most people in the US are familiar. The key difference is that unlike with a 401(k) plan, it has no 10% penalty for withdrawal before the age of 55. These 457 plans can also allow independent contractors to participate in the plan, where 401(k) and 403(b) plans cannot.
Tax withholding, also known as tax retention, pay-as-you-earn tax or tax deduction at source, is income tax paid to the government by the payer of the income rather than by the recipient of the income. The tax is thus withheld or deducted from the income due to the recipient. In most jurisdictions, tax withholding applies to employment income. Many jurisdictions also require withholding taxes on payments of interest or dividends. In most jurisdictions, there are additional tax withholding obligations if the recipient of the income is resident in a different jurisdiction, and in those circumstances withholding tax sometimes applies to royalties, rent or even the sale of real estate. Governments use tax withholding as a means to combat tax evasion, and sometimes impose additional tax withholding requirements if the recipient has been delinquent in filing tax returns, or in industries where tax evasion is perceived to be common.
Deferred compensation is an arrangement in which a portion of an employee's wage is paid out at a later date after which it was earned. Examples of deferred compensation include pensions, retirement plans, and employee stock options. The primary benefit of most deferred compensation is the deferral of tax to the date(s) at which the employee receives the income.
Restricted stock, also known as restricted securities, is stock of a company that is not fully transferable until certain conditions (restrictions) have been met. Upon satisfaction of those conditions, the stock is no longer restricted, and becomes transferable to the person holding the award. Restricted stock is often used as a form of employee compensation, in which case it typically becomes transferable ("vests") upon the satisfaction of certain conditions, such as continued employment for a period of time or the achievement of particular product-development milestones, earnings per share goals or other financial targets. Restricted stock is a popular alternative to stock options, particularly for executives, due to favorable accounting rules and income tax treatment.
For households and individuals, gross income is the sum of all wages, salaries, profits, interest payments, rents, and other forms of earnings, before any deductions or taxes. It is opposed to net income, defined as the gross income minus taxes and other deductions.
A defined contribution (DC) plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis. Individual accounts are set up for participants and benefits are based on the amounts credited to these accounts plus any investment earnings on the money in the account. In defined contribution plans, future benefits fluctuate on the basis of investment earnings. The most common type of defined contribution plan is a savings and thrift plan. Under this type of plan, the employee contributes a predetermined portion of his or her earnings to an individual account, all or part of which is matched by the employer.
Stock appreciation rights (SAR) is a method for companies to give their management or employees a bonus if the company performs well financially. Such a method is called a 'plan'. SARs resemble employee stock options in that the holder/employee benefits from an increase in stock price. They differ from options in that the holder/employee does not have to purchase anything to receive the proceeds. They are not required to pay the (options') exercise price, but just receive the amount of the increase in cash or stock.
For federal income tax purposes, the doctrine of constructive receipt is used to determine when a cash-basis taxpayer has received gross income. A taxpayer is subject to tax in the current year if he or she has unfettered control in determining when items of income will or should be paid. Unlike actual receipt, constructive receipt does not require physical possession of the item of income in question.
The United States Internal Revenue Service (IRS) uses forms for taxpayers and tax-exempt organizations to report financial information, such as to report income, calculate taxes to be paid to the federal government, and disclose other information as required by the Internal Revenue Code (IRC). There are over 800 various forms and schedules. Other tax forms in the United States are filed with state and local governments.
Phantom stock is a contractual agreement between a corporation and recipients of phantom shares that bestow upon the grantee the right to a cash payment at a designated time or in association with a designated event in the future, which payment is to be in an amount tied to the market value of an equivalent number of shares of the corporation's stock. Thus, the amount of the payout will increase as the stock price rises, and decrease if the stock falls, but without the recipient (grantee) actually receiving any stock. Like other forms of stock-based compensation plans, phantom stock broadly serves to align the interests of recipients and shareholders, incentivize contribution to share value, and encourage the retention or continued participation of contributors. Recipients (grantees) are typically employees, but may also be directors, third-party vendors, or others. Business owners may offer phantom stocks as a way to reward and retain employees, however employees can only own phantom stock during the duration of their employment with the company.
Section 409A of the United States Internal Revenue Code regulates nonqualified deferred compensation paid by a "service recipient" to a "service provider" by generally imposing a 20% excise tax when certain design or operational rules contained in the section are violated. Service recipients are generally employers, but those who hire independent contractors are also service recipients. Service providers include executives, general employees, some independent contractors and board members, as well as entities that provide services.
In the United States, the question whether any compensation plan is qualified or non-qualified is primarily a question of taxation under the Internal Revenue Code (IRC). Any business prefers to deduct its expenses from its income, which will reduce the income subject to taxation. Expenses which are deductible ("qualified") have satisfied tests required by the IRC. Expenses which do not satisfy those tests ("non-qualified") are not deductible; even though the business has incurred the expense, the amount of that expenditure remains as part of taxable income. In most situations, any business will attempt to satisfy the requirements so that its expenditures are deductible business expenses.
A Qualified Intermediary refers to a person that acts as an intermediary qualified under certain sections of the U.S. Internal Revenue Code (IRC) to undertake specified activities.
Section 79 of the U.S. Internal Revenue Code sets out the U.S. Federal income tax law concerning term life insurance plans provided by employers. Tax benefits are available for both employers and participating employees, under certain conditions.
Employer compensation in the United States refers to the cash compensation and benefits that an employee receives in exchange for the service they perform for their employer. Approximately 93% of the working population in the United States are employees earning a salary or wage.