The long-awaited Tax Cuts and Jobs Act, released by the House Ways and Means Committee on November 2, 2017, contains significant changes to the taxation of executive compensation and eliminates tax-favored treatment for several employee benefit programs that are popular with employees.
Below is a high-level summary of the proposed changes:
CHANGES IN EXECUTIVE COMPENSATION
1. Elimination of deferred compensation. Starting in 2018, the opportunity to defer compensation would be effectively eliminated. Instead, compensation would be subject to income tax upon vesting (regardless of when it is paid). Existing arrangements would be grandfathered from these rules until 2026 (or later if subject to vesting). Given that many common arrangements like restricted stock units (RSUs), change of control bonuses, severance arrangements and phantom stock agreements can be deferred compensation, this change would significantly affect compensation planning for a broader group of employees, and not just executives participating in traditional deferred compensation plans.
2. Nonqualified stock options no longer viable. Nonqualified stock options would be subject to taxation upon vesting rather than upon exercise. Please stay tuned on this particular issue because we expect that compromises may be made on this topic during the amendment and reconciliation process in Congress. One such compromise that is being discussed would be to leave the current tax rules for nonqualified stock options in place for private companies.
3. Public companies lose deductions on executive compensation. Public companies would lose the ability to exempt performance-based compensation (such as stock options and compensation based on meeting pre-set performance goals) from the $1 million limit on deductible compensation for the top four covered employees of a publicly-traded company (currently, the chief executive officer and the three highest paid officers of the company who are not the chief financial officer). The bill also adds a chief financial officer as a fifth covered employee who would have his or her compensation restricted by this deduction limit.
4. New excise tax on tax-exempt employer executive compensation. Tax exempt employers could be subject to a 20 percent excise tax on compensation that exceeds $1 million for executive-level employees.
CHANGES FOR 401(K) AND RETIREMENT PLANS
1. In-service distributions. In-service distributions for defined benefit plans and state and local defined contribution plans would be permitted without penalty at age 59½ (instead of age 62).
2. Hardship distributions. Participants would not have to wait six months to restart deferrals after taking a hardship distribution, and distributions could include earnings and employer contributions.
3. Outstanding loans. Employees who terminate employment with an outstanding loan would have an extended period of time (beyond the normal 60-day rollover period) to roll over their plan distribution to avoid taxes and penalties on the distribution.
TAX-FAVORED STATUS ELIMINATED FOR EMPLOYEE BENEFIT PROGRAMS
The bill eliminates the tax-favored treatment of several employee benefit programs:
1. Pre-tax benefits under a dependent care flexible spending account or a dependent care assistance program (that is employer funded) would be eliminated.
2. Tuition reimbursement plans would no longer be tax-favored (currently, employers can provide pre-tax tuition assistance to employees of up to $5,250 a year).
3. Transportation fringe benefit plans, adoption assistance plans, qualified moving-expense reimbursement arrangements, employee achievement awards, and Archer medical savings accounts, would no longer be eligible for pre-tax treatment.
Notably, and contrary to the expectations of many in the retirement plan community, the amount that can be deferred on a pre-tax basis into a 401(k) plan was left unchanged in the bill (currently, in 2018, employees would be able to defer up to $18,500 into a 401(k) plan, and employees age 50 and over, $24,500 on a pre-tax basis).
For employers going through or starting open enrollment, it may be prudent to continue operating your compensation and employee benefits programs for the time being. This bill is undergoing further revision in Congress.