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Volume XIII, Number 39


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February 06, 2023

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Tax Reform: Executive Compensation and Employee Benefits

President Trump signed H.R. 1 (formerly, the Tax Cuts and Jobs Act (the “Act”)) into law on December 22, 2017. The Act brings substantial changes to the area of executive compensation, particularly with regard to the deductibility of compensation under Section 162(m) of the Internal Revenue Code, and also makes minor changes in the employee benefits area. Some of these changes are highlighted below, along with the applicable effective dates.

Executive Compensation

Section 162(m) of the Internal Revenue Code

  • The Act Broadens the Reach of the Deduction Limitation. Currently, Section 162(m) provides a $1 million annual cap on the remuneration a publicly held corporation may deduct as to a single “covered employee.” However, the $1 million deduction limitation does not apply to certain payments, including commissions and “performance-based” compensation, including stock options. The Act makes the following sweeping changes to Section 162(m):

    • Repeals the exceptions for commissions and performance-based compensation. As such, stock options, stock appreciation rights, and other equity-based and cash-based performance awards will be subject to the $1 million limit.

    • Expands the definition of “covered employee” to include the CEO, CFO, and the three other highest paid employees, to align with existing SEC rules.

    • Subjects covered employees to the deduction limitation in perpetuity. If an employee is a covered employee at any time on or after January 1, 2017, the deduction limitation will apply to compensation paid to the employee for as long as the corporation pays compensation to the employee or on the employee’s behalf. This includes payments to the covered employee after the individual is no longer employed by the corporation, payments to the covered employee’s beneficiaries paid after the covered employee’s death, and certain payments includible in the income of an individual other than the covered employee, such as payments to a former spouse pursuant to a qualified domestic relations order.

    • Expands the definition of “publicly held corporation” to include all companies that file SEC reports, including foreign issuers publicly traded through ADRs, companies issuing publicly traded debt, and certain large private corporations.

  • Effective Date. These changes apply to the deduction of compensation in tax years beginning after December 31, 2017, unless the transition rule applies.

  • Transition Rule. The revisions to Section 162(m) will not apply to payments made pursuant to a written, binding contract between a corporation and a covered employee in effect on November 2, 2017, provided such contract is not modified in any material manner on or after that date. This transition rule is intended to be narrowly applied and further guidance is needed as to its application.

  • Action Items. Corporations should consider the following steps:

    • Take action before December 31, 2017 to accelerate the accrual of deductions into 2017, including deductions available for cash bonuses payable on or before March 15, 2018, and equity grants payable in 2018.

      • Ensure that the corporation adheres to IRS guidance regarding the actions necessary to support an accrual in 2017.

      • Ensure that the corporation does not certify that particular amounts will be paid to Section 162(m) covered employees.

    • Review existing contracts to determine which are covered by the transition rule. Note that if a contract or plan grants the corporation discretion to determine whether the payments will be made, the contract may not be binding under state law.

    • Review existing contracts and plan documents and consider any revisions that may now be permissible for performance-based pay and whether such changes can be made without shareholder approval. Corporations may consider revising documents that do not fall under the transition rule to reflect the repeal of the performance-based pay exceptions, as corporations will have more flexibility in designing executive compensation arrangements. For example, 162(m)-based provisions (such as prohibitions on positive discretion, individual limits, and the technical certification process) will no longer be applicable.

Excise Tax on Tax-Exempt Organization Excess Compensation

For tax years beginning after December 31, 2017, unless an exception applies, tax-exempt organizations will be subject to a 20% excise tax on compensation over $1 million paid to any of its five highest-paid employees (or, similar to the Section 162(m) revisions, any person who was such an employee in any prior tax year beginning after 2016). The excise tax is also imposed on excess parachute (severance) payments to covered employees of the tax-exempt organization, provided those employees are highly compensated employees for purposes of Section 414(q) of the Internal Revenue Code. There are special rules that exclude some payments to certain medical professionals.

Income Tax Deferral for Qualified Equity Grants by Private Corporations

The Act allows qualified employees to elect to defer taxation for no more than five years of certain stock awards granted by privately held corporations. The election must be made no later than 30 days after the employee’s rights to the stock become substantially vested, and applies to “qualified stock” issued pursuant to stock option exercises or the settlement of restricted stock units (“RSUs”) after December 31, 2017, subject to certain conditions, including the following:

  • The equity awards must be offered with the same rights and privileges to not less than 80% of the company’s employees providing services in the US, the company must not have repurchased any of its outstanding stock in the preceding year (subject to certain exceptions), and the company must comply with certain notice and reporting requirements. The penalty for failure to provide the required notices applies to failures after December 31, 2017.

    • A transition rule provides that until the IRS issues guidance implementing the 80% rule and notice requirements, a company will be in compliance with the Act if it relies upon a reasonable, good faith interpretation of these rules.

  • The following individuals are not "qualified employees" for purposes of the deferral election: the company’s CEO and CFO and any individual who has served in either role; family members of any of the preceding individuals; 1% owners (and those who have been 1% owners at any time during the 10 preceding tax years); and anyone who has, is, or has been one of the four highest paid officers for the 10 preceding tax years.

The Act also confirms that an arrangement under which an employee receives “qualified stock” shall not be treated as a nonqualified deferred compensation plan for purposes of Section 409A by virtue of the deferral option.

Employee Benefits

  • Repeal of Health Insurance Individual Mandate. Although the employer mandate remains, the Act effectively repeals the individual mandate originally enacted by the Affordable Care Act effective for months beginning after December 31, 2018.

  • Repeal of Rule Allowing Roth IRA to Traditional IRA Re-characterization. Effective for tax years beginning after December 31, 2017, IRA owners may no longer use re-characterization to undo a conversion from a traditional IRA to a Roth IRA. However, re-characterization will continue to be permitted for other types of contributions.

  • Plan Loan Rollovers. Effective for tax years beginning after December 31, 2017, if a qualified plan terminates or a participant terminates employment prior to repaying a loan from the qualified plan, the outstanding loan balance will not be treated as a taxable distribution provided the participant contributes the outstanding loan balance to an IRA as a rollover no later than the due date for filing his or her tax returns for that year (including extensions). Prior to the Act, a participant had only 60 days to roll over the outstanding loan balance.

  • Repeal of Exclusion for Various Employer-Provided Benefits, Including:

    • Qualified Moving Expenses. The Act suspends the deduction allowed to employees for qualified moving expenses paid for or reimbursed by their employers from 2018 through 2025. The deduction returns in 2026 (unless there are future changes to tax laws). Special rules apply to members of the Armed Forces.

    • Employee Achievement Awards. Effective for awards given after December 31, 2017, the Act repeals the existing employer deduction for the cost (up to a certain amount) of an employee achievement award, which is an item of tangible personal property given for an employee’s length of service or safety achievement. Further, recipients can no longer exclude the value of the award from their gross income.

    • Qualified Bicycle Commuting Reimbursements. For tax years 2018 through 2025, the Act repeals the existing exclusion of up to $20 per month from gross income and wages for qualified bicycle commuting reimbursements.

© 2023 Jones Walker LLPNational Law Review, Volume VII, Number 356

About this Author

Kelly Simoneaux, Jones Walker Law Firm, New Orleans, Corporate and Securities Law Attorney

Kelly Simoneaux is a partner in Jones Walker LLP’s Corporate & Securities Practice Group. Her practice focuses primarily on the corporate, tax, and securities aspects of executive compensation.

Ms. Simoneaux has extensive experience counseling public and private clients on a variety of compensation related matters, including: advising boards and management on equity-based and other incentive plans and arrangements (including annual bonus plans, stock option and restricted stock plans, phantom equity plans, and employee stock purchase plans...

Tim Brechtel Employee Benefits Attorney Jones Walker

Tim Brechtel began his career with the national accounting firm PricewaterhouseCoopers. His current practice focuses on assisting employers with establishing, administering, merging, and terminating qualified retirement plans, such as 401(k) plans and employee stock ownership plans (ESOPs), as well as nonqualified deferred compensation arrangements under Code Section 409A, health plans, cafeteria plans, severance plans, separation agreements, health savings accounts, flexible spending accounts, transportation, and other fringe benefit plans. His retirement plan...

Katelyn Gunn, Jones Walker Law Firm, New Orleans, Tax and Estate Law Attorney

Katelyn Gunn is an associate in the firm’s Tax & Estates Practice Group and practices in the firm’s New Orleans office. Before joining Jones Walker LLP, Ms. Gunn’s previous legal experience included advising single-employer and multi-employer clients on issues related to qualified pension and welfare plans. Ms. Gunn drafts plan documents, summary plan descriptions, claims and appeals communications, and other documents necessary for plan administration.

She received her juris doctor degree from Tulane University Law School, where she...