At the end of 2017, President Trump signed into law The Tax Cuts and Jobs Act (the “Act”) that includes significant changes in the employee benefits area, most of which became effective on January 1, 2018. The following is a brief description of some of the notable changes, and we expect additional guidance on many of the Act’s provisions.
IRC §162(m) Changes for Public Companies. The Act repeals the performance-based compensation exception to the $1 million pay cap under IRC §162(m) and expands the definition of “covered employee” to include anyone who holds the CEO or CFO position at any time during the tax year plus the three highest paid executive officers for the year. Under the new rules, once a covered employee, always a covered employee with respect to compensation paid in future years - including compensation that becomes payable following retirement (e.g., severance and deferred compensation) and amounts payable to beneficiaries. Under a transition rule, compensation payable pursuant to a written binding contract in effect on November 2, 2017 that is not materially modified thereafter is exempt from the new requirements.
Qualified Retirement Plans
Loan-Offset Rollovers. Previously, a terminated participant who defaulted on a plan loan was deemed to have taken a taxable distribution for the outstanding loan balance unless that amount was contributed to another qualified plan or IRA within 60 days of termination. The Act extends the 60-day period to the due date (including extensions) for filing the participant’s tax return for the year the loan default occurs.
2016 Disaster Relief. Much like the relief provided by the Disaster Tax Relief and Airport and Airway Extension Act of 2017 (see our previous Client Advisory), the Act provides individuals impacted by major disasters in 2016, including Hurricane Matthew, with penalty-free access to retirement funds through qualified distributions of up to $100,000, allows the amount distributed to be repaid over 3 years, and allows taxpayers who cannot repay the distribution to spread out any income inclusion over 3 years. Plan amendments implementing these provisions must be adopted on or before December 31, 2018 (for calendar year plans).
Hardship Withdrawals. Defined contributions plans that allow for safe-harbor hardship withdrawals should examine the extent to which hardship withdrawals may be permitted due to casualty losses as the Act restricts what may be classified as a casualty loss.
Health, Welfare, and Fringe Benefits
Individual Mandate Repeal. The Act eliminates the shared responsibility payment for those individuals who fail to maintain minimum essential health coverage beginning January 1, 2019. The Act does not, however, repeal the employer shared responsibility mandate or reporting requirements.
Paid Leave Tax Credit. Some employers may now claim a federal tax credit of up to 25 percent of wages paid to certain employees for family and medical leave (subject to certain maximums). An employer must generally provide, pursuant to written policies, at least two weeks of annual paid leave at a minimum of 50 percent of regular wages to be eligible for the credit. The credit may only apply to those employees who are employed for at least one year and who earn no more than $72,000 per year (i.e., 60 percent of the highly compensated employee limit for the preceding year). Notably, paid vacation, sick leave, medical leave, personal leave, and other paid time off is not considered paid family and medical leave and amounts paid under state and local laws are disregarded. This provision is temporary, and the credit does not apply to wages paid for leave taken after 2019.
Commuter Benefits. Employers may no longer take a deduction for providing qualified transportation fringe benefits (e.g., mass transit and parking benefits). Moreover, no deduction is allowed for any expense incurred for providing transportation or reimbursement to an employee in connection with travel to and from the employee’s residence and workplace, unless necessary to ensure his or her safety. A special exception applies for qualified bicycle commuting reimbursements, which remain deductible through 2025. While qualified transportation fringe benefits paid by an employer are generally excluded from employees’ taxable income, the Act suspends the exclusion for qualified bicycle commuting reimbursements through 2025. Employees may also continue to pay for these benefits (other than bicycle commuting) on a pre-tax basis through an employer-sponsored salary reduction plan.
Moving Expenses. Except with respect to certain members of the armed forces, the Act suspends the business deduction for moving expenses and the exclusion from employees’ taxable income for qualified moving expense reimbursements through 2025.
Entertainment Expenses. Employers are no longer able to deduct expenses for entertainment, amusement, and recreational activities or for a facility used in connection with such activities even if related to their business.
Meals. The Act imposes a 50 percent limit on the amount employers may deduct for meals provided through an employer-operated eating facility through 2025. Thereafter, the deduction is eliminated altogether. Qualifying employer-provided meals remain excludable from employees’ taxable income.
Achievement Awards. Certain awards granted to employees in recognition of length of service achievement or safety achievement are deductible by the employer and not taxable to the employee (e.g., tangible personal property, like a watch, valued at $400 or less). While the Act does not change these rules, it does codify IRS guidance providing that cash, cash equivalents, gift cards, gift coupons, and gift certificates (other than the right to choose among items pre-selected or approved by the employer) and other intangible property such as vacations, meals, lodging, theater tickets, sporting event tickets, stocks, bonds, and other similar items are not deductible or excludible from taxable income as employee achievement awards.
Private Employer Qualified Equity Grants
Certain employees of private corporations may elect to defer, for up to five years, the income attributable to stock transferred upon exercise of stock options or the settlement of restricted stock units, provided certain requirements are met. Generally speaking, eligibility is conditioned on grants being made under a written plan to at least 80 percent of all U.S. employees. Individuals who are one-percent owners during the current or preceding 10 years, the current or any former CEO or CFO (and any family member thereof), and the four highest paid officers during the current or preceding 10 years are not eligible to make deferral elections. Employers must timely provide notice to employees of their eligibility to defer and report the deferrals on Form W-2. Deferral elections apply for income tax purposes (not for FICA/FUTA purposes), and must be made within 30 days following the date the vested stock is transferred. Importantly, these plans are specifically exempt from 409A and a good faith transition rule applies until further guidance is issued.
Withholding on Certain Equity Awards. Under the Financial Accounting Standards Board’s existing guidance regarding tax withholding on certain equity plan awards, withholding may be as high as the maximum statutory amount necessary to satisfy relevant tax obligations (and negative accounting treatment may result if a higher amount is withheld). As such, because the Act reduces the maximum personal income tax rate from 39.6 percent to 37 percent, to prevent excess withholding, it may be necessary for employers to adjust the manner in which tax withholding is handled.
Withholding on Supplemental Wages. Given the Act’s adjustment of the top personal income tax rate from 39.6 percent to 37 percent, the supplemental tax withholding rate on supplemental wages in excess of $1 million would also appear to be reduced to 37 percent as the supplemental withholding rate is commensurate with the top tax bracket. According to the Act’s Conference Agreement, however, the Secretary of Treasury has the discretion to administer wage withholding rules during 2018 under the rules in place prior to the Act.
Denial of Tax Deduction for Certain Sexual Harassment Settlements The Act prohibits an employer from taking a tax deduction for settlements or payments related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or for attorneys’ fees related to the settlement or payment.
Special Considerations for Non-profit Employers
Taxation of Excess Compensation. The Act adds a new section to the Internal Revenue Code to address “excess” compensation paid to certain employees of tax-exempt organizations for tax years beginning after December 31, 2017. A 21 percent tax will be imposed on applicable tax-exempt organizations, including 501(c)(3) organizations, to the extent the organization pays a “covered employee” remuneration in excess of $1 million in a taxable year or an “excess parachute payment.” A covered employee is one of the five highest compensated employees or one who was a covered employee for any preceding taxable year beginning after 2016. For purposes of determining whether the $1 million limit is reached, remuneration generally includes wages and amounts to be included in income under a 457(f) plan but excludes payments made to a licensed medical professional or veterinarian which are for the professional’s performance of medical or veterinary services. The Act requires remuneration paid on account of employment by one or more related organizations to be aggregated for purposes of calculating whether the $1 million limit is met (and for the related organizations to pay their proportionate share of any applicable tax). An excess parachute payment will occur if a payment is contingent on an employee’s termination of employment and the payment is equal to, or more than, three times the employee’s “base amount” (determining the base amount involves calculating the employee’s average compensation for several years prior to the termination of employment). An excess parachute payment will not occur, however, if the payment is being made to a non-highly compensated employee (the highly compensated employee threshold for 2018 is $120,000).
Disaster Relief Applicable to 457(b) Plans. Under certain circumstances, individuals impacted by major disasters in 2016 are provided access to retirement funds from a 457(b) plan, provided the plan is amended to allow for the distribution (for more detail, see the discussion in 2016 Disaster Relief, above).
Application of UBTI When Providing Certain Benefits. A non-profit entity will be required to recognize unrelated business taxable income (UBTI) to the extent it pays, or incurs costs, for qualified transportation fringe benefits (e.g., vanpooling, mass transit, and parking benefits), parking facilities used for qualified parking, and the use of certain on-premises athletic facilities. UBTI will not apply to the extent the amount paid or incurred is directly connected with an unrelated trade or business which is regularly carried on by the organization.
Length of Service Plans. Under prior rules, certain entities could sponsor a plan whereby bona fide volunteers could earn length of service awards, so long as the annual award for any volunteer did not exceed $3,000. The Act raises this limit to $6,000 (or its actuarial equivalent in the case of a defined benefit plan) and will be subject to cost of living adjustments thereafter.