Deferred Compensation
September 15, 2020
By: Colin A. Walker
In the start-up phase of a business, cash flow is often a difficult issue. R&D, equipment outlays, leasing and other costs often strain the finances of a new business. In such situations, it is common for C-Level executives to defer their compensation to a later stage of the life of a promising business, accepting less now in exchange for more later. However, deferring compensation can run afoul of minimum wage and overtime laws. The federal minimum wage in 2020 is $7.25 per hour and all work over 40 hours in a week must be compensated at time-and-a-half. Many states’ minimum wage laws exceed the federal minimum wage. Some states also provide for enhanced overtime pay, such as time-and-a-half for work done over 12 hours in a day.
However, there are certain “exemptions” from minimum wage and overtime law. One of them is the executive exemption. To qualify for this exemption, the employee’s primary duty must be managing the enterprise or a department or subdivision of the enterprise, he/she must regularly direct the work of at least two other employees, and must have the authority to hire, fire, promote, demote, and make similar decisions. C-Level executives almost always have these duties. There are also exemptions for administrative employees and professional employees which could apply.
To qualify for an exemption, federal law requires the executive to be paid on a salary basis of at least $684 per week ($34,568 per year). Many states’ laws have higher salary thresholds. Because of this, an executive cannot lawfully agree to defer all compensation. The company must pay the executive at least the minimum salary or the minimum hourly wage, plus overtime.
However, additional compensation could be deferred. The best way to do this is to have a carefully-written compensation agreement pursuant to which the executive would be paid the minimum exempt salary but would be entitled to a bonus upon the occurrence of certain events, such as profitability, revenue goals, or release of a key product. If the event does not come to pass, the executive would not be entitled to the bonus and would have received only the salary. Another option would be to pay the executive the minimum hourly wage, but since most executives work outside of normal business hours, and often long hours, hourly pay is difficult and likely to result in violations of wage claim laws.
Executives must be careful of certain tax implications of deferred compensation. Section 409A of the Internal Revenue Code imposes significant taxes on deferred compensation payments under certain conditions. Even severance pay can fall under the purview of 409A under some circumstances. C-Level executives who are deferring compensation should consult competent tax counsel. (This will be the subject of a future blog post.)