The first significant piece of legislation to make it to President Trump's desk, the Tax Cuts and Jobs Act (H.R. 1), includes an employer tax credit for providing paid family and medical leave, elimination of a business expense deduction related to nondisclosure agreements, repeal of the Affordable Care Act’s (ACA) individual mandate, and changes to the tax treatment of certain employer-provided fringe benefits, among others. The massive tax bill merges separate measures the House and Senate passed in November and December, respectively, and was approved by both chambers—after some eleventh-hour amendments to Senate budget rules—on December 20, 2017. The bill is expected to be signed into law by President Trump today.
Passage of the tax bill was the top legislative priority for congressional Republicans and the White House. Congressional leaders and the White House were committed to not repeating the failed effort to “repeal and replace” the ACA by enacting the first sweeping tax reform proposal in 30 years. Having accomplished this goal in a timeline that seemed overly ambitious at the onset, the task now turns to understanding and implementing the complex legislation. Although the bill includes notable provisions for employers, the legislation is also notable for employment and benefits related provisions that were not included in the final package.
Paid Family and Medical Leave Tax Credit
While several state and local governments have enacted paid leave-related bills over the years, federal legislation on this topic has failed to advance. The tax bill offers the first paid leave-related measure at the national level. The bill does not require employers to provide paid leave, but rather offers employers that provide a certain level of paid family and medical leave to their employees a tax credit as an incentive. The law creates a new section in the tax code, Employer Credit For Paid Family And Medical Leave.
How Much of a Credit is Offered?
Eligible employers will be able to claim a general business tax credit equal to 12.5% of the wages they pay to qualifying employees when they take family and medical leave. The credit is available only if the employer pays the employees on leave at least half of their hourly rate (or a prorated amount if they are not paid hourly), and only if the employer provides at least two weeks of paid family and medical leave per year. Employers that pay their employees on leave more than 50% replacement wages will be entitled to a greater tax credit. Specifically, the credit will increase by a quarter percentage point for every percent above the 50% rate the employer pays the employee on leave, up to a maximum tax credit of 25% if the employer pays the employees 100% of their regular wages. This credit is available for up to 12 weeks of paid leave per employee per year.
Which Employees Must Be Offered Paid Leave?
Both full-time and part-time employees must be offered paid leave for an employer to be able to claim the tax credit. Employers must allow part-time employees to take a commensurate amount of paid leave, determined on a pro-rata basis. A “qualifying employee” is an individual who is employed by the employer for at least a year, and paid no more than 60% of the compensation threshold for designation as a highly compensated employee under the tax code, or $72,000 (60% of $120,000, per Sec. 414(g)(1)(B) for 2017).
What Type of Leave Must Be Offered?
The tax credit applies for "family and medical leave," as defined under sections 102(a)(1)(a)-(e)or 102(a)(3) of the Family and Medical Leave Act. Other types of leave such as paid vacation leave, personal leave, or other types of medical or sick leave are not considered family and medical leave for tax credit purposes.
When Would This Leave Apply?
The credit would apply to wages paid in taxable years starting in 2018. The credit would not apply to wages paid in taxable years starting after December 31, 2019.
Sexual Harassment Nondisclosures
The increased awareness of sexual harassment claims has focused attention on nondisclosure agreements in harassment claims settlements. A desire to promote transparency regarding such claims is likely the impetus for Section 13307 of the bill: Denial of Deduction for Settlements Subject to Nondisclosure Agreements Paid in Connection With Sexual Harassment or Sexual Abuse.
The provision would amend section 162 of the tax code, which generally allows businesses to deduct certain ordinary and necessary expenses paid or incurred during the year as part of running the business, to provide the following exclusion:
PAYMENTS RELATED TO SEXUAL HARASSMENT AND SEXUAL ABUSE.
—No deduction shall be allowed under this chapter for—
(1) any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or
(2) attorney’s fees related to such a settlement or payment.
This exclusion will apply to amounts paid or incurred after the tax bill is enacted.
As a practical matter, this means employers will need to decide whether any amount paid to settle a sexual harassment claim is significant enough to be worth the deduction. If so, these employers should ensure their settlement agreements do not include nondisclosure agreements.
Nondeduction of Certain Penalty Amounts
The tax bill also amends Code section 162(f). The new provision denies deductibility for any otherwise deductible amount paid or incurred (whether by lawsuit, agreement, or otherwise) to or at the direction of a government or specified nongovernmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law. Previously, Code section 162(f) only denied a deduction to amounts actually paid to the government. An exception applies to payments that the taxpayer establishes are either restitution (including remediation of property) or amounts required to come into compliance with any law that was violated or involved in the investigation or inquiry, that are identified in the court order or settlement agreement as restitution, remediation, or required to come into compliance.
Therefore, if the government or government entity is a named party in the suit, amounts that do not represent restitution for actual damages (i.e., lost wages or recovery for pain and suffering) but represent a fine or penalty (i.e., treble or punitive damages) are no longer deductible even if paid directly to a plaintiff. Under prior law, these amounts were only nondeductible if paid directly to the government.
Repeal of the ACA Individual Mandate
The tax bill does, at least in part, what the ACA “repeal and replace” effort failed to do – repeal a cornerstone of the landmark health reform bill. Specifically, the tax bill eliminates the penalties for the ACA’s individual mandate, the requirement that most individuals obtain health coverage or pay a penalty. Eliminating the individual mandate will serve to raise revenue to fund other provisions of the tax bill. While the tax bill eliminates the penalties for the ACA individual mandate, the associated employer mandate remains in effect. Both mandates were interrelated and envisioned to work in sync. The removal of the individual but not employer mandate penalties creates added challenge and uncertainty for employers facing enforcement of mandate penalties, onerous reporting requirements and the impending “Cadillac Tax” on employer-sponsored health coverage above a certain threshold. The Cadillac Tax is currently scheduled to become effective in 2020 unless Congress takes action to repeal or delay it. Calls for legislation to stabilize the individual health insurance market no doubt will become even louder in the wake of repeal of the individual mandate penalty. Although the removal of the individual mandate and fate of the individual insurance markets may not initially appear to be of importance to employers, the implications for employer-sponsored coverage are indeed significant.
Fringe Benefit Deductions and Exclusions
The new tax law makes some changes to which fringe benefits can be deducted as a business expense. Specifically, the bill amends section 274 of the Tax Code to provide that deductions are not allowed for "(1) an activity generally considered to be entertainment, amusement or recreation, (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, or (3) a facility or portion thereof used in connection with any of the above items."
According to the conference report, this provision:
repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business (and the related rule applying a 50 percent limit to such deductions).
This section also removes the deduction associated with an employer's providing ordinary commuter benefits to employees.
Employers are still permitted to generally deduct 50% of the food and beverage expenses associated with operating their trade or business, such as meals consumed by employees while on work travel. As explained by the conference report, "for amounts incurred and paid after December 31, 2017 and until December 31, 2025, the provision expands this 50% limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer."
The new tax law also removes the exclusion from employees’ wages for employer-reimbursed bicycle commuting costs, moving expenses and length of service/safety achievement awards.