The Jenner & Block Tax Practice recently issued its own Client Alert discussing the current state of tax reform and the House and Senate bills in more general terms. This Client Alert is focused on executive compensation and employee benefit provisions in the proposed bills. 

Introduction

On December 2, 2017, the US Senate passed its version of the Tax Cuts and Jobs Act (the Senate Bill).  Now that both the House and Senate tax bills have passed, changes to the taxation of executive compensation and employee benefits may be in the offing.

The current Senate Bill proposes major changes to the tax code by removing numerous deductions and exclusions and reforming certain aspects of taxable compensation.  In line with the House Bill, which passed on November 16, regulations affecting executive compensation deductions and the taxation of tax-exempt executive compensation are especially impacted.  However, the previously proposed overhaul of nonqualified deferred compensation has been removed, and existing Code Section 409A rules will remain in effect.  This is the same as the bill that passed in the House.  The current Senate Bill also eliminates the previously proposed easing of restrictions on hardship and in-service distributions from qualified retirement plans.

Process

Even though the House and Senate proposals have numerous similarities with respect to executive compensation, major differences regarding substantial issues, such as individual tax rates and brackets, the Alternative Minimum Tax, and taxation of pass-through entities, will need to be reconciled.  Assuming that the House does not vote to outright accept the Senate Bill, a Conference Committee will negotiate the drafting of a joint bill, which will then go up for a vote in both Congressional chambers. 

The following is a brief summary of the proposed changes to the taxation of executive compensation and other features of the Senate Bill affecting qualified retirement plans and employee fringe benefits.  We will continue to monitor these and other employer-related items.  Please contact any team member listed below or your usual Jenner & Block contact.

Executive Compensation

  • Elimination of proposed Code Section 409B, leaving Code Section 409A in its entirety.
    • As an update to our prior Client Alert, both the House and the Senate removed proposed Code Section 409B, which would have provided that nonqualified deferred compensation would be taxable upon vesting (i.e., as soon as there is no substantial risk of forfeiture).
    • Consequently, nonqualified deferred compensation continues to be governed by the complex Code Section 409A.
  • Code Section 162(m) reform.
    • Similar to the House Bill, the Senate version eliminates the performance-based compensation exemption to the $1 million annual deduction limitation for public companies.  No more deductions (in excess of $1 million) for stock option grants, performance long term incentive awards, or “162(m) wrap bonus” plans.
    • The CFO is also added to the list of covered employees, fixing the glitch created when the SEC changed the proxy reporting requirements in 2006.
    • Companies with publicly traded debt would be subject to Code Section 162(m) in addition to those with publicly traded equity.
    • The deduction limit will continue to apply to covered employees for as long as they receive compensation from the company, even once they are no longer employed.
    • One difference from the House Bill is that binding compensation arrangements already in effect on November 2, 2017, are exempted from the new requirements.
  • Excise taxes on tax-exempt and governmental organizations for excessive executive compensation.
    • Similar to the House bill, the Senate Bill imposes a new 20% excise tax – paid by the employer – for compensation in excess of $1 million to the top five highest paid employees of tax-exempt organizations.
    • A 20% excise tax would also apply to employers paying severance in excess of three times the employee’s base compensation (using the Code Section 280G concept for base compensation).
  • New Code Section 83(i) will allow deferral of certain qualified private company equity grants for up to five years after vesting.
    • Similar to the House Bill, the Senate version adds a new tax deferral feature for grants of private company stock options.  Code Section 83(i), however, may have limited impact due to its narrow scope and complex requirements.
    • Eligible employees may elect to defer the recognition of income from illiquid private company stock acquired from the exercise of stock options or the settlement of restricted stock units (RSUs) for up to five years after vesting, if certain requirements are met.  Elections must be made no later than 30 days after the vesting date.  At the end of the deferral period, income would be recognized based on the value of the qualified stock on vesting date.
    • Code Section 83(i) deferral arrangements are generally exempt from Code Section 409A.
  • Profits interest holding period for long-term capital gains treatment extended to three years.
    • The holding period needed for profits interest (also known as carried interest) to qualify for long-term capital gains treatment will change from one year to three years.
    • This provision applies to gains on either the sale of an interest in a partnership or the sale of investment assets.  Profits interest held less than three years would be taxed at the short-term capital gains rate.

Noteworthy Provisions (not directly related to executive compensation or employee benefits)

  • Denial of deduction for settlement (and related attorney’s fees) of sexual harassment or abuse claims that are subject to a nondisclosure.
    • Business deductions for settlements or fees paid in connection with sexual harassment or sexual abuse claims are disallowed if the payments are subject to a nondisclosure agreement.  As most general releases typically include a release for sexual harassment and abuse (along with everything else), releases going forward may need a carve-out that any confidentiality does not prohibit discussion of sexual harassment or abuse – if the company wants the payments and fees to remain deductible.
  • Employer credits for amounts paid to employees on FMLA leave available through 2019.
    • Eligible employers can claim a tax credit for wages paid to qualifying employees on leave under the Family and Medical Leave Act (FMLA), as long as the wages are at least 50% of the employee’s normal wages.
    • The credit starts at a rate of 12.5% of the wages paid during the period of leave and increases by 0.25% for each percentage point above the 50% wage threshold, up to a maximum allowable credit of 25%.
    • The credit will be available for 2018 and 2019 and will be followed by a Government Accountability Office (GAO) study to measure its effectiveness.
  • Repeal of individual mandate effective 2019.
    • The individual mandate from the Affordable Care Act (ACA) is effectively repealed by reducing the penalty to zero beginning in 2019.  Under current law, the individual mandate creates penalties for non-exempt individuals who do not obtain minimum essential health insurance coverage.
    • The ACA’s employer mandate and annual reporting obligations are not affected.  Employers with 50 or more employees will still need to provide full-time employees with ACA-compliant health insurance or face stiff penalty taxes.
    • The repeal may have direct or indirect consequences on employer-sponsored plans through cost shifting and possible increased insurance costs resulting from healthier individuals leaving the health insurance marketplace.

Qualified Plans

  • Repeal of exclusions and deductions for receipt of certain fringe benefits.
    • Similar to the House Bill, the Senate version eliminates certain deductions and exclusions for employee fringe benefits.
    • Effective 2026, the employer deduction for employer-provided transportation fringe benefits, including parking, transit pass, vanpool and bicycle commuting reimbursements, will be cut, including the accompanying exclusion from the employee’s taxable income.  Employees may still elect to make pre-tax contributions for qualified transportation expenses from their own compensation.
    • Effective 2026, the 50% business deduction for entertainment expenses will be eliminated; however, the 50% deduction for business meals will remain.
    • Effective 2018, employer-paid moving expense reimbursements will now be included in an employee’s taxable income.
  • Repeal of the special Roth IRA conversion rule.
    • Similar to the House Bill, the Senate Bill repeals the rule allowing re-characterization of IRA contributions from one type to the other (Roth to Traditional or vice versa).
  • Easing of plan loan rollover time limit.
    • Similar to the House Bill, the Senate Bill allows employees whose plans or employment terminate to rollover outstanding plan loans to an IRA or other eligible retirement plan by the due date for filing their tax returns without the loan balance being deemed a distribution.  This provision extends the previous 60-day limit.
  • Qualified plan provisions for 2016 disasters.
    • Tax relief is provided to individuals affected by the 2016 flooding in the Mississippi Delta region.  Individuals who suffered economic losses can receive distributions from their eligible retirement plans before the age of 59½ without incurring the 10% early withdrawal tax.  The distributions must occur between March 1, 2016, and January 1, 2018.

As indicated above, significant aspects of the Senate Bill will likely change during Conference Committee negotiations.