On December 15, the House and Senate conference committee reached an agreement on the terms of a final tax bill, which likely will be voted on this week. The final bill largely reflects the Senate’s legislative language, with some modifications. Key provisions affecting compensation and benefits are summarized below. Except as noted, the changes are effective January 1, 2018.
Section 162(m) $1 Million Limit on Deductible Compensation
- Section 162(m) is expanded to apply to any employer with registered securities or that is required to file periodic reports. Therefore, section 162(m) would not be limited to companies with public equity securities; public debt and trading ADRs on a US exchange will generally subject the issuer to these limits.
- The exception to the limit for performance-based compensation is eliminated.
- The covered employee definition is expanded to specifically include the principal financial officer. Also, once an individual is a covered employee in 2017 or later, the individual remains a covered employee with respect to the employer for all future years (regardless of changes in position, compensation or termination of employment).
- A transition rule applies to compensation that is paid pursuant to a written binding contract that was in effect on November 2, 2017.
Eversheds Sutherland Observation: The details of the transition rule remain unclear. For example, if an employment agreement provides for an annual target bonus amount, but the actual annual bonus is determined at the company’s discretion, is it a written binding contract?
Retirement and Medical Benefits
- The amount of a plan loan outstanding at severance from employment or plan termination can be paid to a rollover IRA as late as the income tax filing due date for the year of severance from employment or plan termination, which would avoid inclusion of the remaining plan loan amount in income.
- Recharacterizations of conversions from Traditional to Roth IRAs are no longer permitted. Other types of recharacterizations continue to be permitted, e.g., a Roth IRA contribution can be recharacterized as a Traditional IRA contribution within the permitted timeline.
- The shared responsibility payment (i.e., the individual mandate penalty) of the Affordable Care Act is reduced to zero starting January 1, 2019.
- Several provisions in the Senate and House bills were not included in the final bill, including: additional relief for hardship distributions from 401(k) plans, nondiscrimination testing relief for closed defined benefit plans, and a reduction in the earliest normal retirement age to 59.5 for certain defined benefit plans.
Eversheds Sutherland Observation: There is no change to the employer mandate or the employer’s reporting requirements under the Affordable Care Act. Without a penalty for an individual mandate, however, it may be less likely that an employee not offered affordable coverage by his or her employer will buy coverage on an exchange and receive a tax subsidy. This may decrease the employer mandate penalty exposure for employers, because the penalty is based on whether an employee is covered on an exchange and receives a federal subsidy. Tax-Exempt Employer Compensation
- The final bill imposes a new excise tax at the corporate rate (21%), payable by tax-exempt employers, on:
- Compensation in excess of $1 million paid to the employer’s “covered employees” (the five highest paid employees for the current year or for any prior year from 2017 forward).
- Any “excess parachute payment” (separation-related payments of more than three times the employee’s average compensation over the preceding five years) paid to a covered employee who terminates employment during the year. Excess parachute payments are determined in a manner similar to the current section 280G golden parachute payments. This provision applies regardless of whether there is a change in control.
- The bill includes exceptions for licensed medical professionals to the extent that the compensation is a payment for medical services, individuals who are not highly compensated employees, and payments under certain tax-qualified retirement plans.
Eversheds Sutherland Observation: Tax-exempt employers should check employment agreements, separation pay plans and similar arrangements to determine whether all relevant payments (including severance, nonqualified retirement payments, taxable fringe benefits and other separation-related items) exceed the three-times threshold noted above. If so, it may be appropriate to plan ahead for the excise tax and/or consider restructuring the payments to minimize or eliminate the excise tax.
- The final bill also treats as tax-exempt employer “unrelated business taxable income” certain fringe benefits provided to employees: qualified transportation fringes, parking facilities and on-premises gyms. Under the bill, each of these items will be non-deductible under section 274 for a taxable employer, and presumably the intent is to put the tax-exempt employer in a similar position.
Fringe and Other Benefits
- The taxation of employees on certain non-taxable fringe benefits is modified.
- The exclusion for employer-paid qualified moving expenses is eliminated for tax years 2018 through 2025 (other than for military personnel).
- The bill clarifies that non-taxable employee achievement awards must be in the form of tangible personal property, and that awards would be taxable if provided in other forms such as cash, cash equivalents, gift cards, meals or vacations (though certain gift cards that allow a choice from a limited menu of pre-selected tangible personal property may be non-taxable).
- The exclusion for qualified bicycle commuting expenses is eliminated for tax years 2018 through 2025.
- The final bill does not include other changes proposed in the House bill, including those affecting education assistance programs, adoption assistance programs, dependent care assistance programs, and employer-provided housing.
- Employer deductions for fringe benefits are also modified and limited under section 274.
- Entertainment expenses are not deductible even if “directly related to” the business. This includes meals, travel and club dues, among other items.
- The 50% deduction limit for meals related to operating the trade or business (such as employee meals while traveling for business) remains the same. For 2018 through 2025, the 50% limit also applies to meals provided at on-site eating facilities for the convenience of the employer that meet the de minimis fringe requirements, and after 2025 such meals are non-deductible.
- The employer deduction for qualified transportation and parking fringe benefits is eliminated, other than bicycle commuting expenses for 2018 through 2025.
- Employee commuting expenses are not deductible, except for expenses for the safety of the employee.
Eversheds Sutherland Observation: The bill also replaces CPI-U, the current cost of living index for establishing limits on certain fringe and other benefits, with C-CPI-U starting in 2018. The C-CPI-U index tends to rise slower than CPI-U. Expect that annual limits on benefits such as health FSAs, HSA contributions and the applicable dollar amount under the “Cadillac Plan” tax may rise more slowly with the use of the new index.
- Sexual harassment settlements that are subject to a non-disclosure agreement are not deductible, effective upon the date of enactment.
- Employers can claim a general business credit of up to 25% of wages paid to employees during FMLA leave (subject to certain requirements and limitations). This provision is effective for wages paid in tax years 2018 and 2019.
- Eligible employees can elect to defer the recognition of income from private, illiquid company stock acquired upon the exercise of stock options or the settlement of restricted stock units for up to five years, if certain requirements are met.
- The new provision is limited to companies that grant stock options or restricted stock units to at least 80% of its employees in any given year, so it will typically only apply to start-up companies.
- Deferral elections must be made no later than 30 days after the stock becomes vested.
- At the end of the deferral period, the employee would recognize income based on the value of the stock on the vesting date.