Tax Cuts and Jobs Act - Compensation and Benefits
With the passage of the Tax Cuts and Jobs Act (“Act”), there is much concern, as well as confusion, as to the impact the new legislation has on both businesses and individuals alike. The tax changes contained in the Act are the most sweeping since the Tax Reform Act of 1986. As with any tax change, there will be winners and losers, but all taxpayers should be familiar with how the new legislation could impact their specific situation. Below we address the impact on compensation and benefits.
Elimination of exceptions to public company $1 million compensation deduction limit – With an exception for compensation pursuant to a binding contract in effect on or before November 2, 2017 (and which is not subsequently materially modified), public companies will not be able to deduct compensation in excess of $1 million for their principal executive officer, principal financial officer, and three other most highly compensated officers, due to the elimination of the performance-based compensation and commissions compensation exceptions. Public companies that have been relying on these exceptions may face paying significant amounts of non-deductible compensation to such employees in the future.
Qualified entity stock option and RSU grants – Certain employees of private companies (excluding employees who are 1% and greater owners, the CEO, the CFO, and among the four highest compensated officers) will be able to make limited (maximum of five years) compensation deferral elections for income tax purposes in connection with the income taxability of stock options and/or stock-settled restricted stock units (RSUs), which are exercised/settled in 2018 or after, if they are granted under an equity compensation plan that provides for grants to at least 80% of the employer’s employees.
Widespread use of this deferral election opportunity is not likely due to the 80% coverage requirement, as companies have almost universally limited the grant of stock options and RSUs to members of senior management. Further, the illiquidity of the private company stock that would be received in connection with these grants, combined with the fact that the deferral would be limited to income tax, such that upon exercise or settlement, even where the deferral election is made, the employee may need the funds to meet his or her FICA tax liability, will likely limit the impact of this provision. Perhaps certain smaller and earlier-stage companies that cannot afford to pay significant cash compensation, and which accordingly use stock options and/or stock-settled RSUs to attract and compensate their employees, may have a greater interest in establishing the plans needed for purposes of providing the deferral election opportunity.
IRAS AND TAX-QUALIFIED RETIREMENT PLANS
ROTH IRA recharacterizations – When an individual converts a traditional IRA (pre-tax) into a ROTH IRA (after-tax), the individual must pay the income taxes generated by the conversion from pre-tax to after-tax. However, individuals have also been able to reverse that decision, undo such a conversion, and consequently not incur the resulting tax liability, provided that the reversal is implemented by the individual's tax return due date, including extensions (by the following October 15). As of 2018, the ability to reverse the conversion of a traditional IRA to a ROTH IRA will be eliminated. Consequently, if an individual wishes to reverse the 2017 conversion of a traditional IRA to a ROTH IRA, the reversal must occur by the end of 2017 (rather than by October 15, 2018).
Extension of 60-day rollover period for tax-qualified retirement plan loan offset distribution amounts permits the amount treated as an otherwise taxable distribution from a tax-qualified retirement plan, Section 403(b) plan, or governmental Section 457(b) plan as the result of an unpaid plan loan, to be rolled over after the current law 60-day period. This is provided the deemed distribution occurs after 2017 and the rollover occurs on or prior to the due date (including extensions) for filing the income tax return for the plan participant's tax year in which the amount is treated as distributed.
Tax-qualified retirement plans 2016 disaster relief permits individuals having their principal residence at any time during 2016 located in a “2016 disaster area” (i.e., declared as such by the President) to receive not more than $100,000 of otherwise impermissible in-service distributions from tax-qualified retirement plans, Section 403(b) plans, and governmental Section 457(b) plans, and, if they are younger than age 59-1/2, without imposition of the otherwise applicable 10% early withdrawal tax on those amounts. Individuals receiving such distributions will be able to recontribute the amounts back to the plan (or other eligible plan, such as an IRA or the plan of a new employer) within a three-year period without tax. Alternatively, they will be able to pay tax on the unrecontributed amounts as if the distributions were paid ratably over a three-year period. Plan amendments may be required for this purpose such that affected employers may wish to consult with their attorneys as to any necessary plan amendments that should be adopted for this purpose.
FRINGE BENEFITS AND FAMILY AND MEDICAL LEAVE PAYMENTS
Employee moving expense deduction suspended with an exception for certain moves by members of the armed forces, for 2018 through 2025.
Employer deduction eliminated for certain expenses, including:
- Entertainment, amusement or recreation expenses, including facility expenses, even where business-related (as of 2018).
- Membership dues with respect to any club organized for business, pleasure, recreation or other special purposes (as of 2018).
- Providing qualified transportation fringes (certain parking, transit passes, van pools and bicycle commuting expenses) to employees (as of 2018).
- Except as necessary for ensuring the safety of an employee, the employee’s commuting expenses (as of 2018).
- Providing food and beverages to employees through an eating facility that meets the requirements for de minimis fringes and for the employer’s convenience (after 2025).
Employer reimbursements of moving expenses are fully taxable with an exception for certain moves by members of the armed forces. Employers anticipating the payment of employee moving expenses in the near future may wish to consider making those payments prior to 2018.
Employer credit for compensation paid to employees on paid family and medical leave – For 2018 and 2019 only, an employer with a written policy in effect under which full-time employees can receive not less than two weeks (as well as a proportionate amount for part-time employees) of annual family and medical leave (under the Family and Medical Leave Act of 1993) will be entitled to a general business credit equal to 12.5% of the compensation it pays to certain employees (employed for at least one year and having a rate of compensation not in excess of $72,000 (for 2018) while they are on such a leave. The 12.5% credit amount will be increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
Insights on Impact of the Tax Cuts and Jobs Act