The House GOP tax reform bill introduced Nov. 2, 2017, would have a major impact on employee benefits, including executive compensation, qualified retirement plans, fringe benefits and tax-exempt organizations. If adopted, many of these changes would go into effect Jan. 1, 2018. Although passage of the bill is still uncertain and the bill likely will undergo substantial changes even if it is adopted, employers should understand its potential impact on their employee benefit programs.
- New Regime for Nonqualified Deferred Compensation: The bill repeals Section 409A and replaces it with a new statute, Section 409B, that would govern nonqualified deferred compensation arrangements going forward. Section 409B would operate similarly to the current 457(f)/457A regimes that apply to nonqualified deferred compensation arrangements of tax-exempt organizations and certain tax-indifferent entities. Instead of being subject to income taxation on payment, nonqualified deferred compensation would be subject to income taxation upon vesting (or upon payment, if payment is made within 2.5 months after the end of the year in which vesting occurs).
- Vesting would be based solely on the performance of substantial future services (not performance goals), and noncompetes would not constitute a risk of forfeiture for this purpose. Compensation deferred before 2018 would be exempt but would be required to be included in taxable income by no later than 2025 (or the year in which the compensation vests, if later).
- In a shift likely to have far-reaching implications for equity compensation arrangements, stock options would be treated as nonqualified deferred compensation for this purpose, meaning options would be taxed on vesting instead of exercise. The bill’s application to profits interests is unclear. Section 457(b), governing “eligible” deferred compensation arrangements, would be repealed for tax-exempt employers, and Sections 457(f) and 457A would also be repealed, since they would no longer be necessary if the new rules passed.
- Modification of Limit on Excessive Employee Compensation: The bill repeals the exception to the Section 162(m) $1 million deduction limitation for commission and performance-based compensation paid to a covered employee of a publicly traded corporation. This exception currently applies to compensation payable to covered employees defined to include the chief executive officer (CEO) and the three other highest-compensated officers, but excluding the chief financial officer (CFO). The bill revises the definition of covered employee to include the CFO.
- The bill also provides that once an officer becomes a covered employee, he or she remains a covered employee forever, meaning deferred compensation still would be subject to the $1 million deduction limitation even if paid in a year after the officer ceases to be CEO, CFO or one of the top-paid officers. The bill also would treat beneficiaries of covered employees as covered employees for this purpose. These changes would be effective for tax years beginning after 2017.
- Excise Tax on Excess Tax-Exempt Organization Executive Compensation: The bill proposes a 20 percent excise tax on compensation in excess of $1 million paid to a tax-exempt organization’s five highest-paid executives. The provision would apply to all remuneration paid to such executives, including cash, the cash value of all remuneration (including benefits) paid in a medium other than cash, and excluding payments to a tax-qualified retirement plan and amounts otherwise excludable from the executive’s gross income. The excise tax also would apply to excess parachute payments by the organization to such individuals. An excess parachute payment generally would include a payment contingent on the executive’s separation from employment with an aggregate present value of three times the executive’s base compensation or more. The provision would be effective for tax years beginning after 2017.
Qualified Retirement Plans
- Hardship Distributions: The bill proposes several changes to in-service withdrawals permitted on account of financial hardships. Currently, hardship distributions may only be comprised of amounts actually contributed by an employee and, following a distribution, employees cannot contribute to the plan for the next six months. The bill would modify these rules by (i) allowing hardship distributions to include earnings and employer contributions and (ii) requiring the IRS to issue guidance eliminating the six-month ban on contributions following such distributions.
- Reduction of Minimum Age for Certain In-Service Distributions: The bill proposes to lower the minimum age, from age 62 to 59½ (the same minimum age as for defined contribution plans), for in-service distributions from (i) all defined benefit plans and (ii) defined contribution plans of state and local governments.
- Extended Rollovers for Certain Plan Loan Offsets: The bill proposes to extend the time period in which employees, whose plans terminate or who separate from employment with outstanding plan loans, may contribute the balance of such loans to an IRA to avoid the loan being taxed as a distribution. Currently, such amounts must be contributed within 60 days. The bill proposes to extend the deadline to the due date of the employee’s tax return for the year.
- Modification of Nondiscrimination Rules: The bill proposes to expand cross-testing between an employer’s defined benefit and defined contribution plans for purposes of certain nondiscrimination requirements.
- Repeal of Roth IRA Recharacterizations: The bill proposes to repeal a special rule permitting recharacterization of Roth IRA contributions or conversions to traditional IRA amounts. The repeal is intended to address perceived abuses by such transactions.
- Repeal of UBIT Exemption for Government-Sponsored Plans: The bill proposes to repeal the exemption from unrelated business income tax (UBIT) for government-sponsored retirement plans qualified under Section 501(a).
The bill would eliminate or greatly reduce a number of tax-free employee benefits currently provided by many employers:
- Adoption assistance programs, under which an employer may reimburse an employee on a tax-free basis for up to $13,570 (as indexed for 2017) in qualified adoption expenses, are eliminated.
- Education assistance programs, under which an employer may reimburse an employee on a tax-free basis for up to $5,250 in qualified educational expenses, are eliminated.
- Dependent care assistance programs, under which employees and employers may contribute up to $5,000 on a pre-tax basis to a dependent care spending account to pay for eligible work-related dependent care expenses, are eliminated.
- Employers will no longer be able to reimburse employees on a tax-free basis for eligible moving expenses.
- Employers who provide “achievement awards” such as watches, jewelry, plaques and other tangible items on a tax-free basis to employees reaching service anniversaries or achieving certain safety goals will no longer be able to exclude such gifts from employees’ income.
- Employees living in employer-provided housing as a condition of their employment will be able to exclude from income only up to $50,000 of the value of the housing annually. The $50,000 amount is ratably reduced for certain highly compensated employees.
The proposal also would generally eliminate an employer’s corporate tax deductions or credits for the following types of employee fringe benefits or expense reimbursements:
- Transportation fringe benefits, such as parking, transit passes and commuter expenses
- On-premises athletic facilities and other amenities that are personal in nature and not related to the employer’s business (unless the good, service or facility is otherwise included in the employee’s taxable compensation)
- Work-related entertainment or recreational expenses, including membership dues for such purposes
- Employer-provided child care