1. Base Salary and Incentive Pay Structures
A compensation program combines a fixed base salary with variable pay, and the legal requirements depend on whether the employee is FLSA-exempt and whether the variable pay is discretionary or non-discretionary.
How Should Base Salary and Variable Incentive Pay Be Structured to Avoid Legal Risk?
A compensation program typically begins with a base salary and layers variable incentive pay on top in the form of a cash bonus, commission, or profit-sharing arrangement. The FLSA requires non-exempt employees to receive the federal minimum wage and overtime pay of one and one-half times the regular rate for all hours worked over forty in a workweek, and whether an employee is exempt depends on whether they meet both the salary basis test and one of the defined duties tests.
Executive compensation and contract drafting and review counsel can advise on the most appropriate compensation structure and develop the compensation plan design strategy.
| Compensation Type | Description | Key Legal Consideration |
|---|---|---|
| Base salary | Fixed annual or hourly pay | FLSA minimum wage and overtime; salary basis test |
| Cash incentive / bonus | Variable pay tied to performance metrics | Must be paid if earned; affects overtime regular rate |
| Stock options (ISO/NSO) | Right to purchase stock at exercise price | Section 409A for NSOs; ISO favorable tax; FMV at grant |
| Restricted stock units (RSUs) | Stock delivered upon vesting | Ordinary income at vesting; Section 16 for executives |
| Deferred compensation | Pay earned now but received in a future year | Section 409A governs elections, funding, and timing |
| Clawback | Right to recover previously paid compensation | Dodd-Frank SEC rules require mandatory clawback policies |
Executive compensation and corporate advisory counsel can advise on the compensation structure most appropriate for the specific business and develop the plan design strategy.
What Are the Wage and Hour Compliance Requirements for Compensation Programs?
A non-discretionary bonus earned by satisfying defined criteria must be included in the regular rate of pay for purposes of calculating overtime, which means the employer must look back at the bonus period and pay additional overtime if the employee worked any overtime. Employers with multi-state workforces must comply with state wage and hour laws that may impose higher minimum wages and pay equity obligations.
Employment litigation and consulting and labor laws counsel can advise on the wage and hour compliance requirements and develop the compliance strategy.
2. Equity-Based Compensation: Stock Options, Rsus, and Fmv
Equity-based compensation allows employees to share in the appreciation of company stock, and the tax treatment depends on how the award is structured and how the price is set relative to fair market value.
What Are the Main Types of Equity-Based Compensation and How Are They Taxed?
Incentive stock options can qualify for favorable capital gains tax treatment if the employee holds the shares for the required holding periods, non-qualified stock options are taxed as ordinary income when exercised, and restricted stock units are taxed as ordinary income at vesting. Stock options must be granted at no less than the fair market value on the grant date to avoid treatment as deferred compensation under Section 409A.
Executive compensation and employee benefits counsel can advise on the equity compensation structure most appropriate for the specific company and develop the equity plan design strategy.
Why Does Fair Market Value Matter for Equity Compensation and How Is It Determined?
Fair market value for equity compensation purposes is the price at which the stock would change hands between a willing buyer and a willing seller, and for publicly traded companies the FMV is generally the closing price on the grant date. For closely held companies, the FMV must be determined by a reasonable valuation method, and the IRS gives presumptive validity to valuations performed by an independent qualified appraiser.
Executive compensation and business tax counsel can advise on the fair market value methodology and develop the FMV determination and documentation strategy.
3. Deferred Compensation and Section 409a Compliance
Section 409A imposes strict requirements on nonqualified deferred compensation plans, and a non-compliant plan triggers immediate income recognition, a twenty percent excise tax, and an interest penalty.
What Is Deferred Compensation and What Are the Section 409a Compliance Requirements?
Section 409A governs any arrangement under which an employee earns compensation in one year and receives it in a later year, and a deferred compensation plan must specify in advance the time and form of payment, allow for initial deferral elections only if made before the year of service begins, and restrict subsequent elections to an extension of at least five years. The plan must limit distributions to separation from service, disability, death, change of control, and unforeseeable emergency.
Executive compensation and corporate compliance and risk management counsel can advise on the Section 409A requirements applicable to the specific deferred compensation arrangement and develop the plan compliance strategy.
What Are the Penalties for Section 409a Violations and How Can They Be Avoided?
The penalties for Section 409A violations are applied to the employee, and a participant in a non-compliant arrangement must include in income all vested deferred amounts, pay an additional twenty percent excise tax, and pay interest on the underpayments. Employers must identify and correct Section 409A failures as early as possible because the IRS correction programs allow relief only for certain types of failures.
Executive compensation and employment litigation and consulting counsel can advise on the most significant Section 409A compliance risks and develop the 409A remediation strategy.
4. Clawbacks, Executive Compensation, and Disclosure Obligations
Public companies must disclose executive compensation in the annual proxy statement and implement a mandatory clawback policy under the SEC's Dodd-Frank rules.
What Are Clawback Policies and When Must Companies Implement Them?
The SEC's clawback rules under Dodd-Frank require listed companies to adopt a clawback policy requiring recovery of excess incentive-based compensation paid to executive officers within the three years prior to an accounting restatement, without any ability to exercise discretion to forego recovery unless the cost of recovery would exceed the recovered amount. Companies must file the clawback policy as an exhibit to their annual report.
Executive compensation and corporate governance counsel can advise on the clawback policy requirements, assess whether the current policy satisfies the SEC requirements, and develop the clawback policy design and implementation strategy.
What Are the Sec Disclosure Requirements for Executive Compensation?
Public companies must disclose the compensation paid to their named executive officers in the annual proxy statement, including a Summary Compensation Table, a narrative discussion of each element of compensation, and a CEO pay ratio. Companies must also include a pay versus performance disclosure showing the relationship between actually paid compensation and the company's total shareholder return, net income, and a company-selected financial measure.
SEC compliance and executive compensation counsel can advise on the executive compensation disclosure requirements and develop the executive compensation disclosure strategy.
27 Mar, 2026
