How to Slash Taxes Despite Spikes in Income

Countless high-net-worth individuals are in for a rude awakening in 8 to 20 months. They could have significant tax bills due to significant spikes in income.

Under IRS § 457A, offshore deferred compensation accounts will no longer be permissible, and will need to be included in income, leading to significant “spikes” in taxable income. Who’ll be hit?

Hedge fund principals recognizing offshore (non-taxable) deferred funds. Current deferred amounts must be “repatriated” by the end of 2017.

In addition to hedge fund principals who may experience spikes in income, others may enjoy this “problem” as well, although not as a result of IRS § 457A. This may include real estate fund managers receiving incentive compensation.

Also, executives earning sizeable bonuses or golden parachutes. Collectors selling collectibles for large profits. Individuals recognizing significant Subpart F income from offshore holdings. Investors “who have significant recapture at ordinary income rates upon the sale of an asset.”

But here’s the rub. Many of these individuals want to do the right thing but face conflicting goals. They want to make meaningful donations to a favorite charity and ensure monies are left to their children or heirs, hopefully, tax free. Is it possible? Yes.

Special Trust Vehicles

A mechanism exists that offers a trifecta of benefits to these types of individuals. It’s a special type of trust which serves as a wealth management, charitable giving, and estate planning device all in one. And it offers an irresistible arbitrage right now: high-tax rates with low-interest rates.


Let’s share an illustration that will help you to better understand the power of this unique strategy. Consider the example of a 50-year old hedge fund manager living in New York City. He/she has earned $20 million in ordinary income plus $60 million of offshore deferred compensation, which is coming back to the States.

We advised the manager to set up a special trust with a $10 million contribution. Here’s how the numbers play out:

No Planning Trust Vehicle
Ordinary income $10,000,000 $10,000,000
After Taxes on Income NYC Resident $4,645,000 $10,000,000
Investment Balance at Term (30 years) $12,981,000 $43,229,000
Estate Tax @ 40% $5,192,400 ZERO
Total to Heirs $7,788,600 $43,229,000
Total to Charity ZERO $16,358,000

Quite impressive, isn’t it? All three stakeholders walk away enriched and in gratitude.

Some Issues to Consider

As with all investments, it is essential to do your due diligence, which is why it is important to work with a professional. For example, as a taxable trust, trust income is subject to tax on any ordinary or realized capital gains income, so the nature of the investments owned by the trust are important.

Also, as an irrevocable trust, the trust vehicle is not subject to amendment; once established, it remains in effect under the terms of the trust─no distribution is allowed even in the face of family hardship, financial reversal or medical emergency.

These issues and many other considerations may be discussed with one of the EBS managing directors as you consider this unique solution to your income spikes this year and next. But get started now.

Net Takeaway

The use of a special trust vehicle deserves the respect of the money-wise individual because it fulfills three important desires in your financial life: 1) philanthropic; 2) tax-savings; and, 3) the ability to leave gift and estate tax-free assets to your heirs.

We invite you to a private conversation on how this unique strategy can effectively serve your needs.

Hugh Carter, Managing Director

Chris Rich, Managing Director
617.904.9444 ext. 2

The Complete Private Company Equity Plan Blueprint

Recently, I read a whitepaper from Certent titled The Complete Private Company Equity Plan Blueprint – A comprehensive guide to building your program from the ground up. The whitepaper is quite thorough and discusses the use of equity in private companies and the related:

  • Plan Design
  • Plan Administration
  • Communication
  • Accounting

In addition, the paper has an audit checklist, a great value-add.

In our experience with private companies, executive teams are often challenged to compete with large, public companies for talent where those organizations have endless talent and funding resources to implement best practice equity plans. And, of course, the large, public companies have publicly traded stock that has advantages of volume and liquidity.

To compete in the marketplace for talent, private companies have to think outside of the box. Fortunately, private companies are good at this as they have an entrepreneurial spirit in their DNA; with that DNA, comes the interest by ownership to want their key people to have an owner mindset but without diluting ownership’s equity.

A valuable alternative for private companies to be competitive? Phantom stock plans . This diagram illustrates how phantom stock fits into an overall compensation and benefit strategy:

EBS has created a webinar-on-demand that brings together the key concepts of implementing a phantom stock plan.


The Certant whitepaper describes the considerations for determining what percentage of equity a company should offer in its equity plans. The hard part of this step, however, is to model out the plan variables and scenarios by title, company performance (Multiple of EBITDA? Multiple of Revenue? Multiple of profit?), employee performance, and financial impact to the company

EBS has created a phantom stock plan modeler to help create these detailed scenarios and their financial impact, available at:

Phantom Stock Plan Modeler


A phantom stock plan creates a liability on the sponsoring company’s books. While a plan does not require cash funding, it may be important to plan participants to know that the company is backing up the promise with funding:

  • To provide a degree of benefit security to participants
  • To match plan liabilities with a pool of assets; and
  • To reduce plan cost through tax-advantaged pre-funding.

There are several approaches to plan funding: sinking funds, corporate owned life insurance, mutual funds, and other assets. A detailed funding analysis is necessary to determine the funding type most appropriate for a company.


If funding is set aside, a company can move out from under the regulatory clouds by segregating funds into a Rabbi Trust. The company has a fiduciary obligation to protect your select group’s phantom stock. The essential tension in nonqualified plan design lies between the need to maintain the plan as unfunded (so that benefits are not currently taxable and the plan is not subject to most of Title I of ERISA), but still secures employee benefits.

The most common solution to this dilemma is a Rabbi Trust, which is an irrevocable, employer-established grantor trust set-up by the company to hold assets, separate from the other company assets, for the purpose of paying future participant benefit obligations.

At the centerpiece of a Rabbi Trust is the employer-owner’s commitment to place investments in the trust and to earmark these investments to fund obligations under the plan. A frequent issue in phantom stock plans arises over how does the employer-owner informally fund his or her promise to pay plan benefits.

The Rabbi Trust protects participants from financial events caused by change in control or change in heart of the employer. However, in order for the phantom stock plan and the participant accounts to maintain the tax-deferred status, the assets of the Rabbi Trust are available to general creditors of the company in the event of the company’s insolvency, which means they are subject to the claims of the company creditors.


Trevor K. Lattin
Managing Director
Executive Benefit Solutions