1. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company1 What is it? When is it indicated? Employers can make loans available to executives for specified purposes When executives need cash to meet needs in special situations

2. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company2 Common Loan Situations A mortgage or ‘bridge’ loan when executive is relocating College or private school tuition for members of executive’s family Purchase employer stock Meeting extraordinary needs (e.g. medical, tax, etc.) Purchase life insurance Complete expensive purchase (e.g. car)

3. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company3 Advantages 1.No tax advantages but usually cash is made available at favorable interest rates 2.Some loans exempt from complex tax rules for “below market loans” 3.Employer’s costs for making loan usually low 4.Employer can discriminate regarding term, amount, condition of loans

4. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company4 Disadvantages 1.Complex tax rules for ‘below-market’ loans 2.Unfavorable tax treatment of term loans; employee must include substantial portion of loan in income at times 3.Employer must bear cost of –loan administration –loan default

5. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company5 Tax Implications If loan is –below market –compensation related –a demand loan Interest is treated as 3 transactions – the actual transaction plus 2 ‘deemed’ transactions

6. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company6 Tax Implications Actual transaction: 1.Interest actually paid by borrower is taxable income to company (lender) and may be tax deductible by borrower, subject to usual limitations on interest deductions

7. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company7 Tax Implications “deemed transactions” 2.Employer treated as if paid additional compensation to employee equal to difference between actual rate of interest and “applicable federal rate” this “additional compensation” is tax deductible to employer taxable income to employee

8. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company8 Tax Implications “deemed transactions” (cont’d) 3.Borrower is treated as if paid amount for (2) to employer – this amount is additional taxable income to employer deductible by borrower, subject to usual limitations on interest deductibility

9. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company9 Tax Implications Exceptions to tax rules –Mortgage and bridge loans that meet certain specific qualifications –De minimis loans –No tax effect

10. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company10 ERISA and Other Regulatory Implications No ERISA requirements to meet - executive loans are neither welfare nor pension plans Federal “Truth in Lending” laws may apply Sarbanes-Oxley rule prohibits any publicly traded corporation from making a personal loan to any director or executive officer

11. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company11 Alternatives Loans by employers for full market rates; “bonus” interest cost to executive as additional compensation Guarantees by employer of regular bank loans taken out by executives

12. Loans to Executives Chapter 57 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company12 Discussion Questions 1.What requirements must be met to qualify for the mortgage loan exception and for the bridge loan exception? 2.How is a term loan to an executive treated for tax purposes?