If the pending federal tax legislation is approved and a reduced corporate tax rate becomes effective January 1, 2018, then corporations should consider whether the timing of a bonus payment should be accelerated to allow for a corporate deduction for 2017. The theory behind the foregoing is that, assuming the federal corporate tax rate is reduced effective January 1, 2018, the value of a compensation deduction will be higher for 2017 than it will be for 2018. Thus if the corporation has taxable income for 2017, then a deduction based on a higher tax rate provides value to the stockholders because of the corporation’s increased cash flow.
For calendar year corporations, (i) accelerating the payment of a bonus into 2017, or (ii) fixing in 2017 under the “all event test” the obligation to pay such bonus and making the actual payment no later than March 15, 2018, should allow the corporation to deduct the payment of such bonus for its 2017 taxable year.
To satisfy the “all events test,” (1) all the events must have occurred to establish the liability factually, and (2) the amount of such liability must be determinable with reasonable accuracy. These two prongs could be satisfied, for instance, by a binding corporate resolution in 2017 to pay certain individuals specified amounts in early 2018, and by eliminating any requirement that the employee be employed with the corporation on any date after December 31, 2017. While such action may not be historically consistent with the timing of bonus payments, such inconsistency can be explained in a positive manner because a higher deduction rate would generally increase stockholder value.
For public corporations concerned about the performance-based compensation exception to the $1 million limit under Internal Revenue Code Section 162(m), and since the terms of most incentive plans do not require corporations to use audited financial statements for the determination of whether the performance-based criteria were satisfied, an analysis should be performed to determine whether unaudited financial statements could be used by the Compensation Committee to certify whether applicable performance-based metrics were achieved. A corporation would want to try to use financial results as reflected in such unaudited financial statements for purposes of eligibility to deduct such bonus payments for 2017 if audited financial statements could not be obtained by the March 15, 2018 deadline for payment of the bonuses. To that end, a corporation should review the terms of the incentive plan, and determine whether an amendment may be necessary if the Compensation Committee seeks compliance with the all events test and, if such an amendment is necessary, the repercussions, if any, from a disclosure and shareholder approval perspective.
Additionally, any payment acceleration should be reviewed to determine whether any adverse tax consequences under Internal Revenue Code Section 409A will occur.