On November 3, 2017, the Chairman of the House Ways and Means Committee issued the long-awaited tax bill, H.R.-1 the Tax Cuts and Jobs Act (the “Bill”), which proposes to modify the tax code by simplifying and reforming tax exclusions, deductions and taxable compensation, as well as, simplifying and transforming major facets of executive compensation.
While passage of this Bill remains an open question, if corporate tax rates are going to be reduced, this Bill indicates there will likely be a fundamental shift in the tax treatment of deferred compensation going forward. The proposed Bill, which currently purports to be generally effective after December 31, 2017, would specifically impact executive compensation, qualified plans, and employee fringe benefits in the following ways.
The Bill released November 2 (then marked up by the Chairman and released as a substitute on November 3) was accompanied by a section-by-section summary and is the first step in the tax writing process. The House Ways and Means Committee has scheduled the mark up of the Bill beginning at noon, Monday, November 6, 2017, and it is being reported that the markup bill is expected to be ready for full House consideration the week of November 13th. The Senate Finance Committee is reporting that its members are close to finalizing the Senate’s tax proposal with reports of its publication the second week in November. Thereafter, the bills will be reconciled in a conference committee that will negotiate and draft a new bill that both the House and Senate will have to pass, unless one chamber can agree to pass the other’s without change.
The following is a brief summary of the proposed executive compensation changes as well as some other features of the Bill affecting qualified retirement plans. We will continue to track these and other employer-related items.
- Traditional deferred compensation is eliminated post-2017.
- New Code Section 409B would provide that nonqualified deferred compensation would be taxable upon vesting, as soon as there is no substantial risk of forfeiture.
- This change potentially applies to equity programs, including restricted stock units, stock options and stock appreciation rights (“SARs”). As before, restricted stock would continue to be governed under Code Section 83(b).
- Existing deferred compensation arrangements for services performed through 2017 would be grandfathered until 2026.
- Repeal of Code Section 409A. The convoluted and complex Code Section 409A would remain in effect for grandfathered programs for the transition period described above, but acceleration to comply with the new rules would be permitted.
- Code Section 162(m) reform.
- The performance-based compensation exemption would be eliminated, making Code Section 162(m) more of a true $1 million 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 added back in, fixing the glitch created when the SEC changed the proxy reporting requirements in 2006.
- Companies with publicly issued debt would be subject to the limits of Code Section 162(m).
- Another significant change is that once an employee is treated as a Code Section 162(m) “covered employee”, he/she remains classified as a covered employee as long as he/she receives compensation from the company – even once they are no longer employed by the company or would have otherwise fallen out of covered employee status.
- Excise taxes on tax-exempt and governmental organizations for excessive executive compensation (let’s call it the “Nick Saban Rule”).
- A 20% excise tax – paid by the employer - would be applied to compensation over $1 million provided 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 3 times the employee’s base compensation (using the Code Section 280G concept for base compensation).
- Earlier in-service distributions from qualified plans.
- Plans may be amended to allow in-service withdrawals at age 59.5 from all retirement plans. As before, this is a permitted change for plan sponsors but not required.
- This change, effective 2018, brings uniformity to in-service distribution options from state and local government plans, defined benefit plans, and defined contribution plans.
- Easing of hardship requirements.
- Employees withdrawing from their retirement plans due to financial hardships may continue contributions to the plan. The Bill would eliminate the six month waiting period previously required to resume contributions.
- Beginning 2018, hardship withdrawals may include account earnings and employer contributions, not only employee contributions.
As indicated above, this Bill travels next to the Ways and Means Committee and is likely to change there to reflect, in part, public reaction to many of the vast changes proposed.