The Tax Cuts and Jobs Act, as initially proposed by the U.S. House of Representatives on November 2, 2017, includes provisions that would dramatically impact many common incentive and deferred compensation programs, including the potential demise of stock options. If adopted, these provisions would significantly limit U.S. businesses in their flexibility to design competitive compensation programs tied to their specific business needs. It will push companies towards annual-only performance periods, time-vesting conditions for longer periods, and less use of equity compensation — all contrary to the best interests of growing and innovating our economy.
Summary of §409B
Section 3801 of the Tax Cuts and Jobs Act would create a new section, Internal Revenue Code (IRC) §409B, that, among other things:
- Drastically reduces the ability to defer compensation for all U.S.-taxpayer employees and other service providers (directors and consultants) at all levels of for-profit businesses — public companies, private companies, start-ups, etc.o Applies to all levels of service providers — not just highly paid executives.
Requires income to be recognized when compensation is no longer subject to a “substantial risk of forfeiture” (SRF), with a much narrower definition of SRF than under current tax law: o SRF can be based only on requirement to provide substantial future services (in other words, time-vesting). o Specially excludes SRF based on performance conditions (as currently permitted under IRC §83 and §409A). o Specifically excludes SRF based on compliance with a noncompete (as currently permitted under IRC §83).
Broadly defines “nonqualified deferred compensation” (NQDC) to include any amounts that could be paid later than March 15 of the year after the year the SRF lapses, with explicit exceptions for qualified retirement plans, certain welfare benefit plans (for example, vacation and disability), and transfers of property (excluding options) subject to IRC §83, and specifically includes as NQDC: o Stock options and stock appreciation rights; and o Restricted stock units (RSUs) and other forms of phantom equity.
- Applies to all compensation earned for services beginning January 1, 2018 — so the impact would be immediate — and requires an end to all pre-2018 deferrals by the end of 2025.
Major Impacts to Common Compensation Arrangements
As proposed, §409B would effectively end — or require dramatic redesign of — many common compensation arrangements used today:
§409B appears intended to be a revenue-raising provision that is unrelated to any driving policy concerns or issues. The Tax Cuts and Jobs Act includes a number of other revenue-raising provisions that would impact compensation and benefits programs, including the elimination of the performance-based compensation exception and other changes to the $1 million deduction limit under IRC §162(m). None are as potentially significant or challenging to for-profit businesses as §409B.