Tax Cuts & Jobs Act: Tax Reform Implications for Executive Compensation and Employee Benefits
The 2017 tax reform act referred to as the Tax Cuts and Jobs Act (Act) was signed into law Dec. 22, 2017. The law affects executive compensation and employee benefits in several ways. This alert provides a brief overview of some of the changes.
New private company deferral opportunity for qualified stock awards. The Act contains new Internal Revenue Code Section 83(i), which provides a deferral opportunity for non-executive employees of privately held companies. If an employee receives a stock option or restricted stock unit grant they will have 30 days to elect whether to defer taxation of the resulting compensation when those options or restricted stock units vest. The deferral will last until the earlier of (i) five years, or (ii) the occurrence of certain specified events, including when the stock of the company becomes readily tradable on an established securities market, or when the employee revokes his deferral election.
New excise tax on executive compensation paid by tax-exempt organizations. The Act imposes a 21 percent excise tax on compensation in excess of $1 million per year, including excess parachute payments, paid to an exempt organization’s five highest-paid employees.
Increase in profits interest holding period. Certain profits interest issued in connection with the performance of services now must be held for three years, rather than one year, to benefit from long-term capital gains treatment.
Changes to Internal Revenue Code Section 162(m) deduction limit on public companies. Section 162(m) imposes a $1 million per person limit on the federal income tax deduction that may be taken by a publicly held corporation for remuneration paid to certain executives. The Act makes a number of changes to Section 162(m) that are summarized in the five points below:
- There will no longer be an exception for remuneration that is performance-based or payable on a commission basis. This means for taxable years beginning after December 31, 2017, except for “grandfathered” amounts, all remuneration paid to a “covered employee” by a publicly held corporation during a taxable year will be subject to the $1 million limit. Remuneration in excess of the limit for the year will not be deductible.
- The “covered employees” subject to the limits imposed by Section 162(m) will now include an employee who is (1) the principal executive officer or the principal financial officer of the taxpayer at any time during the year, or (2) an employee whose compensation must be reported to shareholders under securities laws by reason of being among the three highest compensated officers for the taxable year (other than the principal executive officer or the principal financial officer). Previously, only the principal executive officer as of the end of the taxable year was included under (1), so the new rule will pick up anyone serving in that position or as the principal financial officer at any time during the year.
- The “covered employee” definition in future years will include an individual who was a covered employee of the taxpayer for any preceding taxable year beginning after December 31, 2016. This means, unlike the former rule, compensation paid to a former employee after termination of employment or even death will still be subject to the Section 162(m) limit. This will apply to nonqualified deferred compensation and severance pay as well as other amounts paid after an employee’s termination of employment.
- The definition of “publicly held corporation” for this purpose is expanded to include certain corporations that are issuers as defined in Section 3 of the Securities Exchange Act of 193This includes corporations with publicly traded debt and some foreign companies that were not previously covered.
- A transition rule states the changes will not apply to remuneration provided pursuant to a binding written contract that was in effect November 2, 2017, and which was not modified in any material respect on or after such date. The scope of the transition rule is not clear at this time, so until guidance is issued employers may want to avoid making changes in plans and agreements that could be subject to these rules.
Qualified Retirement Plans
Additional time to avoid deemed distribution of plan loans. The Act extends the time period during which an employee, whose plan terminates or who terminates employment with an outstanding plan loan, may contribute the balance of such loan to an IRA or another employer plan to avoid the loan being taxed as a deemed distribution. Prior law required such amounts to be contributed within 60 days after the plan or employment termination; the Act extends this deadline to the due date (including extensions) of the employee’s tax return for the year.
Health, Welfare and Fringe Benefits
Effective elimination of ACA individual mandate. The Act reduces the tax that applies if an individual does not obtain individual health insurance to zero, effective for months beginning after December 31, 2018. The obligation of certain employers to provide affordable group health plan coverage under the Affordable Care Act has not changed.
Changes to deductibility of certain fringe benefits. The Act eliminates employers’ deductions for transportation fringe benefits and imposes stricter limits on the deductibility of business meals and entertainment expenses. Entertainment expenses generally are nondeductible, with certain exceptions, including office parties. Business meals provided for the convenience of the employer are now only 50 percent deductible and will be nondeductible after 2025.