Chapter Summary

This chapter has examined how the tax system affects decisions relating to employee compensation. Employers and employees are separate taxable entities and determine their taxable income by different principles; however, they also interact in ways that bind them together in a common decision process. Employers who are sensitive to the tax status of their employees can develop compensation programs that maximize the after-tax income of those employees and, at the same time, minimize the company's after-tax cost.

There are a number of compensation methods available besides the basic ones, which are salaries, commissions, and bonuses. Employers can compensate employees indirectly by providing benefits that those employees would otherwise have to acquire on their own from after-tax salaries. Although some of these benefits are taxable to the employee, the amount taxable may be less than the value to the employee. For example, when employers can purchase benefits for less than retail cost, the employee is taxed only on the discounted cost. Certain other benefits are not taxable to the employee. The savings the employer gains by obtaining benefits at a lower cost and by the reduction of income taxes can be passed on to the employees or shared between the employer and the employees.

As well, employers can help to maximize their employees' long-term wealth accumulation. By utilizing tax-deferred compensation methods such as RPPs, DPSPs, and stock-based investment plans, employers can substantially increase their employees' savings, as well as the returns on those savings.

Whenever possible, the employer should offer a range of compensation alternatives so that it meets the needs of the greatest possible number of employees. At first glance, this may seem more costly to the employer; however, in the long run, the providing of benefits that have greater after-tax value to the employee will result in a more cost-efficient compensation program. In this regard, it is important to explain to employees the value, in terms of cash equivalents, of each alternative form of compensation. Flexible and creative compensation programs can improve productivity and in so doing make the business more competitive.