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Impact of 2016 Elections: Tax Code Reform and Executive Compensation

President-Elect Donald Trump’s new administration is likely to work with congressional Republicans to pursue significant changes to the Internal Revenue Code (IRC). During the campaign, Mr. Trump’s tax proposals focused primarily on

  • reducing the maximum corporate tax rate to 15%,

  • eliminating the alternative minimum tax, and

  • simplifying individual tax brackets from seven to three and lowering the maximum rate.

If enacted, these proposals could materially affect the design of executive compensation programs.

Reduced Corporate Tax Rate

If corporate rates decrease, businesses may be less concerned about tax deductions for compensation because the value of a tax deduction would be reduced. Companies might use the performance-based compensation exemption of IRC Section 162(m) less frequently, leading to more flexibility in how performance-based compensation arrangements are structured. There would be less need for objective, predetermined performance targets, which are often driven by Section 162(m) compliance.

Elimination of Alternative Minimum Tax

Incentive stock options (ISOs) may make a comeback if the alternative minimum tax is eliminated and tax deductions are less valuable. With ISOs, the gain between the grant date and the exercise date may be taxed as capital gain. By contrast, the gain on nonqualified stock options is taxed at ordinary income rates. Despite the more favorable tax treatment for employees, ISOs have fallen out of favor because many employees lose any tax benefit when an ISO gain is subjected to the alternative minimum tax, and a company generally loses a tax deduction on ISOs. If the alternative minimum tax is eliminated and corporate tax rates are reduced, we may see a resurgence of ISO use to motivate employees.

Deferred Compensation and Lower Maximum Rates

Given the political focus on tax reform, the use of deferred compensation could be significantly affected. Lower current income tax rates would make deferred compensation less attractive, especially if there is concern about tax increases in future years. Employees and directors who make deferral elections with respect to 2017 compensation will have to determine whether they think 2017 tax rates will be lower than the tax rates in a future payment year and balance that rate differential against the value of tax deferral. 

As the new administration takes shape, we will continue to monitor the potential effect of tax reform proposals on executive compensation.

Copyright © 2018 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

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About this Author

Mims Maynard Zabriskie, Executive Compensation Attorney, Morgan Lewis Law firm
Partner

Mims Maynard Zabriskie is a partner in Morgan Lewis's Employee Benefits and Executive Compensation Practice, resident in the Philadelphia office. Ms. Zabriskie designs and helps clients implement executive compensation programs, equity compensation plans such as stock option plans and tax-qualified retirement plans. Ms. Zabriskie counsels clients on a wide variety of legal issues that arise in connection with employee benefit plans. Ms. Zabriskie has an extensive background in working with Fortune 500 companies, technology and bio-tech companies and other publicly and privately owned...

215-963-2921
Callie M. Kim, Morgan Lewis, employee benefits lawyer, executive compensation attorney
Associate

Callie M. Kim focuses on employee benefits and executive compensation for public and private companies. Callie helps companies design and implement compensation plans to attract, motivate, and retain top talent. She advises on qualified and nonqualified retirement plans, health and welfare plans, and executive compensation arrangements. She also counsels clients on the legal issues arising under ERISA, the Internal Revenue Code, and securities laws. Callie draws on prior professional experience in emerging growth companies to bring an accessible, practical, and client-focused approach to her law practice.

215-963-5612