H.R.1 as amended, the Tax Cuts and Jobs Act (TCJA), was passed by the U.S. House of Representatives, in a 227 to 205 vote, on November 16, 2017. The Senate Finance Committee version of the bill, most recently amended November 16, has been approved by the Committee and is anticipated to go to the Senate for a vote next week. The flurry of activity has seen “new” Code Section 409B come and go and preserved, for the moment, the current timing for taxation of most forms of executive deferred compensation. The good news is that it appears, for now, that tax reform will not have a substantial impact on the timing of taxation of equity and non-equity deferred compensation awards.
As we reported in our prior alert, the initial versions of the House and Senate tax reform proposals would have seen stock options and restricted stock units (RSUs) taxed at the time of vesting, with “vesting” being tied to a concept of a substantial risk of forfeiture based solely on future performance of substantial services. Current common deferred compensation designs which tie “vesting” to events such as a “change in control” would have no longer provided an effective means of tax deferment.
Below is an updated summary of “what’s in” and “what’s out”:
- For non-qualified stock options (NSOs) and RSUs, timing of taxation remains as under current law. However, there is a “new” tax deferral opportunity for private company equity-based awards granted under certain broad-based employee plans (covering at least 80% of employees on a controlled group basis) and exercised (in the case of NSOs) or settled (in the case of RSUs) after 12/31/17. The new opportunity involves a new “Code Section 83(i) election” which can be made by an eligible employee within 30 days after an applicable vesting date and can serve to defer taxation for up to five years after vesting of the awards. Employer notices will be required. A company’s CEO, CFO and 1% owners will not be eligible for the election.
- For ISOs, under current law, upon exercise, the amount of “spread” between the fair market value of the option upon exercise and the exercise price is used for purposes of determining the Alternative Minimum Tax (AMT) owed by the grantee making the exercise. Under the House and Senate versions, the AMT is “out”. The elimination of the AMT will apply to tax years after 12/31/17.
Both the House-passed TCJA and the Senate version retain the following:
- For public companies - elimination of Code Section 162(m) performance-based compensation exception to the $1 million deduction limit (e.g., equity compensation no longer excluded); will cover CEO, CFO plus three highest paid employees (and their beneficiaries) and will apply regardless of when paid. The Senate version still contains an expansion to the type of employers affected (e.g., large private C or S corporations and foreign corporations traded through ADRs) and grandfathers compensation provided under written contracts in effect as of 11/02/17 and not materially modified after such date.
- For tax-exempt organizations - application of a 20% excise tax on compensation paid in excess of $1 million to any of the five highest paid employees for the tax year (any year after 2016). Once an employee qualifies as being a covered person, the characterization survives so long as the organization pays him or her remuneration. In addition, a 20% excise tax will apply to any amounts paid on a separation from service with an aggregate present value of three times or more of the employee’s “base compensation”.
The Senate is expected to vote on its version of tax reform next week. Stay tuned.