Diverse array of taxable and nontaxable fringe benefits

Hunter is a single 45-year-old who is employed by an engineering firm that includes a diverse array of taxable and nontaxable fringe benefits within the overall compensation package it offers its employees. Employees receive a base salary in addition to occasional incentive awards (i.e. bonuses); the incentive awards are often in the form of noncash perks. The company also offers different forms of equity-based compensation to reward its highest performing employees.
Hunter does not itemize deductions, and he does not have any available tax credits or estimated tax payments. His employer withheld $23,668 from his paychecks for income tax withholding.
Hunter’s base salary for calendar-year 2018 was $101,350. He embarked on an all-expenses-paid 5-day Caribbean cruise in April 2018, which he received from his employer in lieu of a cash bonus. The cruise and related travel expenses would have cost Hunter $4,025 if had paid for the trip out-of-pocket. His employer agreed to give Hunter an extra $1,375 in cash to cover his tax liability on the value of the cruise (referred to as a “tax gross-up”). Tax gross-up payments are included on an employee’s paycheck as ordinary wages subject to income and payroll taxes.
Hunter also took advantage of the following pre-tax payroll deductions:
• Annual employee contribution to employer’s 401(k) qualified plan = 6% * $101,350 base salary = $6,081/year (his employer provides a 75% match as well, i.e. $4,560.75/year)
• Annual employee contribution to a flexible spending account (“FSA”) = $2,400/year
• Annual employee contribution to health insurance plan = $1,440/year
A summary of the above-mentioned compensation details is provided in the following table:
Description 2018 Amount
Base salary $101,350
Non-cash incentive award – all-expenses-paid cruise vacation $4,025
Tax gross-up for the non-cash incentive award $1,375
Payroll deduction – Employee 401(k) contributions $6,081
Payroll deduction – Employee FSA contributions $2,400
Payroll deduction – Employee portion of insurance premiums $1,440
Income taxes withheld from paychecks $23,668

Hunter is a highly-valued engineer at the company and thus has been rewarded quite handsomely the past few years with several equity-based compensation awards. In 2018 Hunter decided to sell 4,360 shares of stock that he received pursuant to the terms of these awards.
Type of Equity Award Section 83(b) Election? Number of Options/Shares Granted Grant Date FMV/share @ Grant (Exercise Price) Vest Date FMV/Share @ Vest Exercise Date FMV/Share @ Exercise Number of Shares Sold Sale Date Sales Proceeds per Share
Restricted Stock Yes 610 shares 1/1/2016 $9.50 1/1/2018 $11.75 610 5/1/2018 $17.50
Restricted Stock No 950 shares 1/1/2017 $11.30 1/1/2018 $11.75 950 5/1/2018 $17.50
Restricted Stock Yes 1,225 shares 1/1/2018 $11.75 1/1/2019 $10.90
Nonqualified Stock Options 100 options – 7 shares per option 1/1/2016 $9.50 1/1/2017 $11.30 1/1/2017 $11.30 700 5/1/2018 $17.50
Nonqualified Stock Options 200 options – 7 shares per option 1/1/2017 $11.30 1/1/2018 $11.75 1/1/2018 $11.75 1,400 5/1/2018 $17.50
Incentive Stock Options 100 options – 7 shares per option 1/1/2016 $9.50 1/1/2017 $11.30 1/1/2017 $11.30 700 5/1/2018 $17.50
Incentive Stock Options 200 options – 7 shares per option 1/1/2017 $11.30 1/1/2018 $11.75 1/1/2018 $11.75
(See excel spreadsheet for chart above)
In addition to his base salary, incentive award and equity-based compensation, Hunter also received the following taxable AND non-taxable fringe benefits from his employer during 2018:
Fringe Benefit Description Company’s Annual Cost Hunter’s Annual Cost
Health insurance The company offers health insurance* to all employees. The monthly premium for each employee is $300, of which the company pays 60% and the employee pays 40% via a pre-tax payroll deduction.
Hunter elected to receive health insurance coverage for 2018. $2,160/year $1,440/year Accidental death and dismemberment (“AD&D”) insurance The company provides AD&D insurance to all employees, free-of-charge. $180/year $0 Fitness facility membership The company offers a fitness facility membership to all employees, free-of-charge. The fitness facility is not located on the company’s business premises and is open to the general public.
Hunter elected to receive a membership in the fitness facility for 2018. $816/year $0 Employer-provided cell phone The company provides all engineers with a company phone, due to frequent after-hours client calls as well as the significant number of clients residing outside of the United States. Employees are not allowed to use their company phone to make personal calls. $444/year $0 Basic group-term life insurance policy The company provides group-term life insurance ($50,000 policy) to all employees, free-of-charge. $90/year $0 Supplemental group-term life insurance policy The company offers supplemental group-term life insurance to all employees. The supplemental life insurance coverage employees can elect is capped at 8 times their base salary or $500,000, whichever is lower.
*Hunter elected to receive the maximum allowable $500,000 in supplemental life insurance for 2018. $900/year $240/year
Employer-provided meals The company provides catered lunches to all employees on Mondays and Wednesdays, free-of-charge. The meals are furnished for the convenience of the company and are provided on the company’s business premises. $1,352/year $0
Qualified parking The company provides qualified parking access at a parking garage located on the company’s business premises to all employees, free-of-charge. $3,900/year ($325/month) $0

Compute the amount of cash Hunter saved in 2018 because he chose to take advantage of payroll deductions made available to him by his employer. Hint payroll deductions related to 401(k) contributions only reduce the amount of an employee’s taxable wages reported on Form W-2, Box1 ( i.e. employee still owe FICA taxes on the portion of their payroll deductions related to 401(k) Contributions). In contrast. Payroll deductions related to flexible spending accounts and health insurance reduce the amount of an employee’s taxable wages reported on Form W-2, Boxes 1, 3, and 5.
Answer: $1296
Hunter’s marginal tax rate of 24% (income tax rate only) and 31.65% (income tax rate + Social Security tax rate + Medicare tax rate) should be used as applicable for this analysis and your answer should be shown as a positive amount and rounded to ZERO decimal places.
What amount (if any) will Hunter’s employer report as taxable wages on his 2018 Form W-2 with respect to his restricted stock equity awards? If Hunter does not have any 2018 taxable wages related to his restricted stock equity awards, please input 0 for your response (i.e. do not leave the answer blank).

When employees make a Section 83(b) election with respect to their restricted stock grant, they do so under the assumption that the company’s stock price is going to increase before the restricted stock vests.
There are certain trade-offs the employee must be willing to live with if they make a Section 83(b) election: (1) the possibility of having to recognize taxable wages in an earlier tax year (if the vesting date occurs in a year subsequent to the grant date), (2) the risk that the stock price will actually decrease instead of increase, and (3) the risk that they may leave the company or otherwise forfeit their right to the restricted stock before the vesting date.
Compute the amount of cash that Hunter could have saved if he had the benefit of hindsight and could avoid making any unfavorable Section 83(b) election decisions. In other words, if Hunter could have minimized his taxable wages related to his restricted stock grants in 2016, 2017 and 2018, what would the difference have been in the total income taxes and FICA taxes he actually paid?
You may assume Hunter’s taxable wages each year were taxed at a combined rate of 31.65% (24% marginal tax rate + 7.65% FICA). Do not consider any present value implications when computing the cash savings that Hunter missed out on

Answer: $1223

What amount (if any) will Hunter’s employer report as taxable wages on his 2018 Form W-2 with respect to his restricted stocks? If Hunter does not have any 2018 taxable wages related to his restricted stock, please input 0 for your response (i.e. do not leave the answer blank).

Answer: $18330

During 2018, Hunter sold 1,560 shares of stock he acquired when the related restricted stock awards became vested. He sold the shares for $17.50/share. What is Hunter’s stock basis for the shares that were sold, along with the holding period of the shares.

Answer: 610 Shares-restricted stock
Stock basis= 610 * 11.75 (FMV on vest date) =7,168 holding period starts 1/1/2018
950 Shares- restricted stock
Stock basis=950 shares*11.75(FMV on vest date) =11,163 holding period starts 1/1/2018

What amount (if any) will Hunter’s employer report as taxable wages on his 2018 Form W-2 with respect to his incentive stock options (“ISOs”)? If Hunter does not have any 2018 taxable wages related to his ISOs, please input 0 for your response (i.e. do not leave the answer blank).

Answer: $0

During 2018, Hunter sold 2,100 shares of stock he acquired upon exercise of the related non-qualified stock options. He sold the shares for 17.50/share. Choose the option below that correctly represents Hunter’s stock basis for the shares that were sold, along with the holding period of the shares.

Answer: 700 Shares exercised 1/1/2017
Basis=700 shares* (11.30 – 9.50)(taxable wages aka “bargain element”)=$1,260 holding period 1/1/2017
1400 Shares exercised 1/1/2018
Basis=1400 shares* (11.75 – 11.30)(taxable wages aka “bargain element”)=$630 holding period 1/1/2018

Compute Hunter’s short-term capital gain he must include in taxable income as a result of his 2018 stock sales.
Combine the short-term capital gain from each type of equity-based compensation award (if applicable) – i.e. if the short-term capital gain was $10 for the restricted stock and $12 for the NSOs, but there was no short-term capital gain from the sale of ISOs, your answer would be $22.
Answer: $41,520

Hunter’s tax liability associated with his short-term capital gain will be taxed at his marginal tax rate of 24%. How much cash could Hunter have saved if he had waited until after January 1st, 2019 to sell the shares of stock that were acquired on January 1st, 2018?
Hint: Hunter is not in the bottom two or top income tax bracket. Determine the appropriate preferential rate that would apply instead for a long-term capital gain. To calculate the cash savings Hunter missed out on by selling those shares before 1 year had passed, multiply his short-term capital gain you computed in the previous question by the difference between his marginal tax rate and the applicable preferential tax rate.
Answer: $3,737

Compute Hunter’s long-term capital gain he must include in taxable income as a result of his 2018 stock sales.
Combine the long-term capital gain from each type of equity-based compensation award (if applicable) – i.e. if the long-term capital gain was $10 for the restricted stock, $12 for the NSOs and $8 for the ISOs, your answer would be $30.

Answer: $8,680

What are the correct amounts Hunter’s employer should report in Box 1, Box 3, and Box 5 of his 2018 Form W-2?
Answer: Box 1 $125,271
Box 3 $131,352
Box 5 $131,352

When Hunter was hired by his company several years ago, he was required to complete Form W-4 “Employee’s Withholding Allowance Certificate” He followed the guidance provided in the “Personal Allowances Worksheet” and decided to claim two (2) allowances on his Form W-4. He has not changed his election of 2 allowance since he was initially hired (although he is not precluded from do so at any point during the year)
For 2018, one (1) withholding allowance reduces an employee’s taxable wages by $4150 (this amount is adjusted each year by the IRS)
Employers compute an employee’s federal income tax withholding using the formula below and report it on Form W-2 Box 2
W-2 Box 1 wages – $8,300 (2 allowance * 4,150/allowance) = Net taxable wages* tax (computed using tax tables updated annually by the IRS)= Federal income tax withholding
Hunter’s employer withheld federal income taxes of 23,668 from his paychecks. Hunter’s 2018 form 2040 showed a $3,273 income tax liability owed to the IRS.
Question: If Hunter had chosen zero withholding allowances instead of two when he was hired, how much would he have owed on his 2018 From 1040 of the 3,273 he actually owed? Use Hunter’s marginal tax rate of 24% for your analysis. Your answer should represent the total revised tax amount (NOT the variance between the revised and actual amount owed) Hint as withholding allowance increase, the amount of federal income tac withheld from an employee’s paycheck will decrease, which in turn will increase the amount of taxes owed on Form 1040 (and Vise Versa)
Answer: $ 5,265

When Hunter was hired by his company several years ago, he was required to complete Form W-4 “Employee’s Withholding Allowance Certificate” He followed the guidance provided in the “Personal Allowances Worksheet” and decided to claim two (2) allowances on his Form W-4. He has not changed his election of 2 allowance since he was initially hired (although he is not precluded from do so at any point during the year)
For 2018, one (1) withholding allowance reduces an employee’s taxable wages by $4150 (this amount is adjusted each year by the IRS)
Employers compute an employee’s federal income tax withholding using the formula below and report it on Form W-2 Box 2
W-2 Box 1 wages – $8,300 (2 allowance * 4,150/allowance) = Net taxable wages* tax (computed using tax tables updated annually by the IRS)= Federal income tax withholding
Hunter’s employer withheld federal income taxes of 23,668 from his paychecks. Hunter’s 2018 form 2040 showed a $3,273 income tax liability owed to the IRS.
Question: If Hunter had chosen six withholding allowances instead of two when he was hired, how much would he have owed on his 2018 From 1040 of the 3,273 he actually owed? Use Hunter’s marginal tax rate of 24% for your analysis. Your answer should represent the total revised tax amount (NOT the variance between the revised and actual amount owed) Hint as withholding allowance increase, the amount of federal income tac withheld from an employee’s paycheck will decrease, which in turn will increase the amount of taxes owed on Form 1040 (and Vise Versa)
Answer: $ 9,249

Sample Solution

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