Finally! An Answer to Local Taxation of Non-Qualified SERP Benefits in Ohio

Qualified retirement plan benefits paid by pension or 401k plans have always been exempt from local taxes in Ohio.  Non-qualified retirement plans (often referred to as “Supplemental Executive Retirement Plans” or “SERPs”) are often designed to enhance retirement benefits for executives over and above the benefits provided through the qualified plans offered by the employer.  Over the last several years there has been disagreement between cities in Ohio and SERP eligible executives over whether benefits paid by SERPs are retirement plan benefits, exempt from local taxes, or deferred compensation benefits, subject to local taxes when such benefits become vested using FICA and Medicare (“FICA”) taxation rules.

SERP participants have alleged that SERPs are retirement benefits which should be exempt from local taxes just like qualified retirement plan benefits. Cities have argued that non-qualified SERPs are taxable compensation to the executive. The disagreement rose into the public eye in 2015 in the case of MacDonald vs. Shaker Heights when the Ohio Supreme Court ruled in favor of MacDonald. The local tax ordinance in that case did not exclude SERPs and further, did not specifically define “pension benefits” which were exempt from local taxation. After this ruling, many cities amended their tax ordinance to define pensions as benefits paid only by a qualified retirement plan. Many taxpayers have argued these Ohio cities should not be able to tax retirement benefits….whether paid by a qualified or non-qualified plan. But there has been little or no guidance from Ohio on the issue…..until recently.

local taxation and non-qualified SERP benefits

What’s New in 2020?

Ohio House Bill 166 amended ORC 718 and clarifies the definitions of “pension” and “retirement benefit plan”. This prevents cities from defining such terms in their tax ordinances to require taxation of non-qualified pensions and retirement benefits.  All pensions and benefits paid out of a retirement benefit plan are exempt from local taxes if the benefits meet the following criteria:

  • The benefits are provided by the Employer and not through a deferral of wages by the employee;
  • The benefit payments must be due after or at termination of employment; and
  • The plan is designed to deliver the benefits because of retirement or disability

HB166 does not define “retirement”; therefore, it will be up to plan documents to define what constitutes a retirement. Retirement definitions vary from plan to plan, but it is typically defined by age and/or years of service. Wage continuation, severance payments, and payments of accrued vacation are specifically not included in retirement plan benefits.

Thus, whether paid by a qualified or non-qualified plan, if these criteria are met, the benefits are retirement plan benefits exempt from local taxes in Ohio. Eligibility for the exemption in SERPs is going to be a facts and circumstances analysis comparing the plan design to the criteria above and intent of the plan. The new rules were made effective January 1, 2020. SERP benefits taxed by municipalities prior to 2020 are not refundable. However, eligible SERP benefits which become vested on or after January 1, 2020, even if they have accrued over a long career, are exempt from local taxes.

Taxation Timing

SERPs are subject to FICA taxes under special rules….the present value of the benefit is generally taxed when the benefit becomes vested, even if this is prior to payment.  There is an exception for non-account balance plans which benefits cannot be determined until retirement.  Ohio local taxes follow the FICA rules for tax timing. HB166 did not change these tax timing rules. However, if the benefits qualify as “pension” and “retirement benefit plans” under HB 166, the benefits are exempt from local tax if vested on or after January 1, 2020. Starting in 2020, collection and remittance of city income taxes for an eligible SERP is no longer necessary, assuming it meets the facts and circumstances analysis.

Ineligible Benefits

Examples of executive benefits that would be ineligible for the local income tax exclusion:

  • Benefits provided through elective deferrals on the part of the employee
  • Any payment of benefits prior to termination of service, retirement or disability
  • Benefits delivered through long term incentive plans, such as phantom stock plans, which do not promise benefits because of retirement or disability
  • Benefits under a plan which provides a participant with an election to be paid prior to retirement or disability, even if the participant did not make the election
  • Severance payments, payments made for accrued personal or vacation time, and wage continuation payments.

Outcomes

As a result of HB 166, the taxation of SERPs by Ohio municipalities has been resolved. Properly designed SERP benefits will be exempt from income tax by Ohio municipalities, just like qualified retirement plan benefits.

Many employers currently have a SERP; those plans should be evaluated to determine if it meets the exemption criteria. Employers should stop reporting and withholding local wages and taxes starting in 2020 if they deem the plan(s) to be a “retirement benefit plan”.

Some school districts within Ohio have their own income tax.  There are no changes to the taxation of school district income tax as a result of HB166. School District Income taxes follow Ohio taxing guidelines rather than FICA, so participants would be taxed when benefits are paid.

For questions regarding the impact of this legislation on your organization’s Non-Qualified SERP Benefits or how to navigate these changes, please contact the Findley consultant you normally work with, or Brad Smith below.

Published May 28, 2020

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Copyright © 2020 by Findley, Inc. All rights reserved

Compensation and Retention Strategies for Healthcare Executives

To thrive today, healthcare organizations must provide competitive compensation and implement strategies to recruit and retain talented executives. Short- and long-term incentive plans – along with retention arrangements – are increasingly being tied to successfully vying for healthcare’s top talent.

Healthcare organizations compete for the best leadership talent by offering a unique and compelling value proposition that includes a balance of mission served, performance challenges, engagement of diverse stakeholders, and competitive compensation.

It’s essential that these organizations use total rewards strategies to successfully guide the design, administration and governance of their pay and benefit programs. The strategy should be developed and designed to support the organization’s strategy (i.e. incent growth and performance, utilize the financial resources of the organization, etc.) and culture. Top-performing health systems have written strategy statements that are board-approved and shared with existing and potential employees.

Compensation and Retention Strategies for Healthcare Executives

The value of benefits and perquisites make up a smaller percentage of executive total rewards. There are fewer executive benefits (i.e. executive medical insurance, supplemental disability plan, etc.) and many organizations are offering executives the same benefits offered to other employees. Limited executive perquisites are the new norm and any enhanced benefits and/or perks must be justified as having a legitimate business purpose.

Establish a Compensation Strategy for Executive Talent

Compensation is a key element of the total rewards strategy to attract and retain the best leadership, and healthcare systems should develop a compensation framework that includes:

  • Base salary
  • Short-term incentives
  • Long-term incentives
  • Retention incentives

Base Salary

Base salary is fixed compensation that typically does not vary according to performance or organizational results. It pays for experience, knowledge and individual performance. It is common practice to establish and maintain a salary administration program with two objectives: providing base compensation that is competitive with the market, and controlling fixed costs. In addition, the program should ensure that pay is internally equitable when compared to similar positions within the organization.

The majority of organizations target base salaries at the market median, which is the 50th percentile. Likewise, recent surveys and Findley’s industry experience indicates 65% of healthcare organizations target leadership base salaries at the market median. The next most popular target, used by 15% of organizations, is to set the range at the 60th or 65th percentile of market.

In practice, not all salaries will be equal to the target and there are a number of valid reasons why salaries may vary from the target. The salary administration program has pay ranges that allow management and the board flexibility to determine salaries by evaluating factors that include individual experience, market rates, length of service and business needs.

Short-Term Incentives

Top-performing organizations design short-term incentive plans, (also know as annual incentive plans), to award incentives using an objective and disciplined approach. The plan should reinforce the philosophy that executives are connected to organizational results; it should motivate and drive appropriate behaviors and deliver rewards that are in alignment with organizational success and growth.

“Recent research and Findley’s industry experience, indicate formal short-term incentive plans are used in more than 75% of healthcare organizations.”

Compensation and Retention Strategies for Healthcare Executives Guide

Long-Term Incentives

Long-term incentive plans are emerging as important components in compensation strategies for healthcare systems as the plans prove valuable in retaining and recruiting top talent. Based on market studies and Findley’s experience, offering long-term incentive plans varies by the size of the organization, with more than 40% of organizations with net revenue greater than $2 billion featuring long-term incentive plans in their compensation programs.

As organizations look for long-term performance-based compensation solutions, there are a variety of options to consider. One solution that is growing in popularity is a performance-based long-term incentive plan that awards cash at the end of a multi-year performance period based on the achievement of predetermined goals.

“Boards of directors in this pay-for-performance era are seeking alternatives to deliver long-term performance-based compensation.”

Compensation and Retention Strategies for Healthcare Executives Guide

Another approach that is becoming more common is the “performance-based” SERP. This combines the planning and techniques used for defined contribution SERPs, along with the performance measurements of an annual incentive pay plan. This option offers competitive long-term compensation, assuming adequate levels of sustained annual performance.

Long-term incentive plan options vary, too, between for-profit and non-profit healthcare organizations. For-profit healthcare systems are able to include some type of “equity” award in the total compensation package for executives. Executives in the non-profit, tax-exempt healthcare environment lack the opportunity of real “ownership.” Measuring long-term value is even more important with a tax-exempt organization because the “shareholders” are taxpayers and members of the community.

Historically, long-term plans have been merely an accumulation of short-term metrics over a multi-year period. The trend has shifted and long-term or value-focused metrics force a more strategic or visionary view of future guideposts for success. While financial results remain important, organizations are including more measures that focus on growth, market share, community impact, and employer brand.

Retention Incentives

One component that has seen significant growth over the last several years is the implementation of retention compensation. The healthcare industry in particular has been on the forefront due to the recent and expected future consolidation of hospitals and healthcare systems.

Often, retention incentives occur in instances of an anticipated transaction which requires continuity in order to execute transition plans and maintain the ongoing value of the enterprise. It can be essential to ensure that key talent is retained, operating functions are held intact, and relationships are maintained during a significant transition (i.e. pending sale, reorganization or new leadership).

The structure of retention arrangements varies as some organizations may choose to incorporate retention benefits within individual employment agreements, while others create standard agreements or policies for groups of executives.

Learn more about our findings and the solutions to implementing effective and creative strategies to recruit and retain talented executives in the healthcare industry in this guide below:

Compensation and Retention Strategies for Healthcare Executives Guide

Design and Implement an Effective Compensation Strategy

The healthcare industry is going through significant transformation and it is imperative for organizations to have well-designed executive compensation programs with retention strategies to recruit and retain top talent. Designing and implementing effective plans requires:

  • Taking a total rewards and total compensation planning perspective;
  • Aligning the compensation plan design with the mission and strategies of the organization;
  • Creating and maintaining conditions that are favorable to delivering competitive compensation and;
  • Designing retention strategies that align the interests of the executives with the stakeholders.

Questions or need advice on implementing an effective compensation strategy or successful incentive programs at your organization. Please contact Jen Givens or Tom Hurley by filling out the contact form below.

Published May 15, 2020

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Copyright © 2020 by Findley, Inc. All rights reserved.

The Impact of Double Trigger Change on Control Agreements

Challenge

A community bank was planning a sale to a larger regional bank and our discussion with the community bank’s attorney focused on the change in control agreements for the executives.

A great deal of work had been done when the agreements were initially established – and the agreements were designed to protect the community bank’s executives in the event of a change in control. At the time, we determined the amount of the severance (enhanced to 18 months or two times base salary, compared to a one times salary for other situations) and carefully considered the triggers that would result in payment of the severance. We concluded that a double trigger agreement was in the best interests of the shareholders.

Did it make sense to accelerate all of the severance when not all of the executives are entitled to it under the agreements in place?

Both a change in control and a termination of employment would be required for a double trigger. Double triggers would also pass the scrutiny of the proxy advisors.

Now, with the sale of the bank being negotiated, the plan was to accelerate and pay all severance for each executive at closing. All executives would receive severance checks, even those who were not losing their jobs.

Why was it necessary to reconsider the severance protection for this executive team? Did it make sense to accelerate all of the severance when not all of the executives are entitled to it under the agreements in place?

The Impact of Double Trigger Change on Control Agreements

Solution

In this case, the severance protection extended to contingent or good reason terminations. All of the executives would lose their current positions and enable the severance even though they may receive offers for new positions with the acquiring bank.

In addition, the acquiring bank was not willing to accept the existing agreements. The regional bank provides similar, but different, protections to their executives and they didn’t want to set a precedent of having different agreements in place for their executive team.

As a condition of the transaction, the acquiring bank required all executive agreements of the community bank to be extinguished. New and consistent agreements were developed at the appropriate levels for the executives who would be retained after the acquisition.

“Cashing out” double trigger agreements at closing is very common, especially if there are good reason termination provisions in the agreements. Acquiring banks do not want to deal with severance costs after the transaction and they prefer that the shareholders of the selling bank absorb the costs for the promised severance. Acquiring banks want to selectively identify and extend employment and retention agreements to the executives they wish to retain.

Double Trigger Results

The community bank (a publicly-traded company) set the merger approval process to include a separate filing that asked shareholders to approve (in a “say on pay” advisory vote) the new change in control agreements and severance payments at closing. These amendments are nearly always approved; if the shareholders want the deal, they will approve the amendment.

For the community bank, the shareholders approved the change in control amendment by a narrow margin, while the sale of the bank passed by a landslide. A review of the votes shows the institutional shareholders (represented by the proxy advisors) cast the votes against the amendments. Non-institutional shareholders wanted the sale and approved the change in control agreement amendments.

Double trigger agreements can be quite complicated. The agreements are almost a necessity when established to gain acceptance of proxy advisors, however, double trigger agreements often will reduce to single trigger agreements at the time of a change in control for the various reasons mentioned above, notwithstanding the objection of proxy advisors.

When establishing change of control agreements for executives, single trigger agreements may provide a simpler solution.

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