On Friday, December 15, 2017, Congress put forth a final version of the Tax Cuts and Jobs Act, which would signify the largest piece of tax legislation in over thirty years if signed into law. Early in the morning on December 20, the Senate voted to pass the bill, and the House later approved it on the same day. The bill is on its way to President Trump’s desk, and most expect the bill to be signed into law when he receives the package just in time for Christmas. So what does this mean from an executive compensation standpoint?
As previously discussed in our blog posts entitled Senate Stays Up Late to Approve Tax Bill, dated December 5, 2017, Thanksgiving Tax Frenzy – New Tax Bill Proposes Executive Compensation Changes That Could Derail Deferred Compensation and Stock Options on November 14 and Startups Have Much To Be Thankful For – Senate Amendments to New Tax Bill Remove Deferred Compensation and Stock Options from Endangered Species List on November 16, which discussed the various differences between the Senate’s and House’s versions of the bill, the tax bill will cause significant changes regarding deductions for excessive employee remuneration and the treatment of qualified equity grants.
Both the House and the Senate versions of the bill provided that the annual $1 million limitation placed on public companies in deducting compensation made to certain “covered employees” would be modified. Previously, so-called qualified performance-based compensation was excluded from the $1 million limitation so that public companies could provide this type of compensation and deduct all of it as employee compensation. Both the House and Senate versions of the bill repealed this exception, and that repeal was carried through to the final bill.
Covered employees will now include the CEO, the CFO and the three highest paid officers of the company, and once an employee qualifies as a “covered employee,” that $1 million deduction limitation will continue to apply to that employee for so long as he or she receives compensation payments from the public company. The final bill also includes the Senate’s transition or grandfather rule, which applies to remuneration that is provided pursuant to a written binding contract which was in effect on November 2, 2017, and which was not modified in any material respect on or after such date. As described in the conference committee report, suppose an employee hired by XYZ Corporation on October 2, 2017 was eligible to participate in the company’s deferred compensation plan in accordance with the terms of the plan in existence prior to November 3, 2017, and receives payments under that plan after November 2, 2017. Such payments under the plan would be grandfathered from the new rules, even if the employee is not an actual participant in the plan on November 2, 2017 (e.g., the employee is not eligible to participate until after November 2, 2017) and the payment of such deferred compensation amounts would not count toward the $1 million limitation. Note that any renewal of a contract is treated as a new contract entered into on the day the renewal takes effect.
The final bill’s proposal regarding the treatment of qualified equity compensation grants remains the same as the Senate proposal (which largely followed the House proposal), with some modifications. In general, qualified employees may elect (no later than 30 days after the first time the employee’s right to the stock is substantially vested or is transferable) to defer for up to five years, the inclusion in income of the amount of income attributable to qualified stock transferred to the employee by the employer, which stock is granted in connection with the performance of services. However, certain excluded employees (e.g., top executive officers) would be precluded from this benefit. Additionally, such elections may only be made with respect to stock received from an eligible corporation, which includes a non-public corporation that has a written plan under which not less than 80% of all employees who provide services to the corporation in the United States are granted stock options or restricted stock units with the same rights and privileges to receive qualified stock. The final bill approved by Congress clarified this 80% requirement to say that the requirement is only met if in a taxable year, all such employees are granted stock options or restricted stock units for that year, and not a combination of both types of awards. We previously noted that such 80% participation threshold will likely limit the use of qualified equity grants in practice.
Further, the alternative minimum tax remains intact but for tax years beginning after December 31, 2017 and before January 1, 2026 the final bill would increase the exemption and exemption phase-out amounts for individuals.