# Question

The accompanying table can be used to make paired comparisons of the desirability of salary, deferred compensation, and pensions as a function of a = current and future employer marginal tax rates, b = current and future employee marginal tax rates, c = the earnings rates on investment that the employer and employee can achieve, and n = the number of periods of compensation deferral. Use the table to answer the following questions and explain how the table enables you to determine the answers.

Where

• tco and tcn are employer current and future marginal tax rates.

• Thus a > 1 (a < 1) implies that employer tax rates are expected to increase (decrease).

• tpo and tpn are employee current and future marginal tax rates, respectively; thus b > 1 (b < 1) implies that employee tax rates are expected to increase (decrease).

• n denotes the number of time periods (i.e., length of the employment contract).

• r1 and r2 denote interest rates; the precise definitions vary depending on the compensation comparison for which the table is use

d. To get you started, recall from Chapter 8 that salary will be preferred to deferred compensation if:

Given the definitions of a, b, and c, in the table, Equation 8.2 can be rewritten as bcn > a = a/bcn < 1 and, in defining c, r1 = rpn and r2 = rcn.

a. If r1 = rpn and r2 = rcn, what do table values greater than 1.00 tell you about the desirability of salary relative to deferred compensation?

b. What portion of the table—that is, which rows and columns—is relevant to a comparison of salary and pensions? What are the appropriate definitions of r1 and r2 in this case? And what do table values greater than 1.00 tell you?

c. What portion of the table is relevant to a comparison of pensions and deferred compensation? What are the appropriate definitions of r1 and r2 in this case? And what do table values greater than 1.00 tell you? You have been asked to provide tax-planning assistance in formulating compensation policy for several of your corporate clients. You have three types of clients, each with seven types of employees:

d. For the case of rp = rc = rpen, for which employee/employer/length-of-the- employment-contract (EEL) combinations would you recommend that marginal compensation dollars be allocated to each of the following?

1. Salary

2. Deferred compensation

3. Pension

e. Consider only employer client 3 and employees 1, 3, and 7. For the case of rp = rc and rpen exceeding rc by approximately 2%, for which of the relevant EEL combinations would you recommend that marginal compensation dollars be allocated to each of the following?

1. Salary

2. Deferred compensation

3. Pension

Where

• tco and tcn are employer current and future marginal tax rates.

• Thus a > 1 (a < 1) implies that employer tax rates are expected to increase (decrease).

• tpo and tpn are employee current and future marginal tax rates, respectively; thus b > 1 (b < 1) implies that employee tax rates are expected to increase (decrease).

• n denotes the number of time periods (i.e., length of the employment contract).

• r1 and r2 denote interest rates; the precise definitions vary depending on the compensation comparison for which the table is use

d. To get you started, recall from Chapter 8 that salary will be preferred to deferred compensation if:

Given the definitions of a, b, and c, in the table, Equation 8.2 can be rewritten as bcn > a = a/bcn < 1 and, in defining c, r1 = rpn and r2 = rcn.

a. If r1 = rpn and r2 = rcn, what do table values greater than 1.00 tell you about the desirability of salary relative to deferred compensation?

b. What portion of the table—that is, which rows and columns—is relevant to a comparison of salary and pensions? What are the appropriate definitions of r1 and r2 in this case? And what do table values greater than 1.00 tell you?

c. What portion of the table is relevant to a comparison of pensions and deferred compensation? What are the appropriate definitions of r1 and r2 in this case? And what do table values greater than 1.00 tell you? You have been asked to provide tax-planning assistance in formulating compensation policy for several of your corporate clients. You have three types of clients, each with seven types of employees:

d. For the case of rp = rc = rpen, for which employee/employer/length-of-the- employment-contract (EEL) combinations would you recommend that marginal compensation dollars be allocated to each of the following?

1. Salary

2. Deferred compensation

3. Pension

e. Consider only employer client 3 and employees 1, 3, and 7. For the case of rp = rc and rpen exceeding rc by approximately 2%, for which of the relevant EEL combinations would you recommend that marginal compensation dollars be allocated to each of the following?

1. Salary

2. Deferred compensation

3. Pension

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