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On November 2, 2017, the House Republicans released the text of the Tax Cuts and Jobs Act (the “House Bill”), laying out a broad set of changes to the tax code that could dramatically change the ways companies compensate, incentivize, and provide benefits to employees. Below is a high-level summary of the proposed changes we will be following. Generally, the proposed effective date for these provisions are for compensation attributable to services performed, or tax years beginning, after 2017.
Non-Qualified Deferred Compensation (“NQDC”)
- NQDC will be taxed as soon as there is no longer a substantial risk of forfeiture (i.e., receipt of the compensation is not subject to future performance of substantial services).
- “Substantial risk of forfeiture” will be narrowly defined as the future performance of services and will not include either (i) compliance with a covenant not to compete, or (ii) satisfaction of a performance goal that relates (nominally or otherwise) to a purpose of the compensation.
- With respect to equity-based compensation, NQDC would include stock options and stock appreciation rights, but not property under Code Section 83 (other than options) or “profits interests.”
- Repeals Code Sections 409A and 457(f).
- Grandfathered Plans: The House Bill provides a transition period through 2026 for existing NQDC arrangements related to services performed on or before December 31, 2017. “Grandfathered” NQDC will remain subject to current tax law provisions during the transition period. We anticipate there will be limited modifications permitted to NQDC during the transition period without losing the grandfathered tax treatment.
Elimination of Performance-Based Exception to Excessive Employee Remuneration
- Code Section 162(m) limits tax deductions for payments in excess of $1 million to certain top executives (the “covered employees”) of publicly traded corporations. The House Bill repeals two key exceptions to the $1 million deduction limitation and expands the group of executives who are classified as covered employees.
- The current exception for commissions and performance-based compensation paid to covered employees is eliminated.
- The definition of “covered employee” is expanded to include the CEO, the CFO, and the three other highest paid employees. This aligns the definition with current SEC disclosure rules.
- Once an executive is classified as a covered employee, the deduction limitation will continue to apply to that individual during any period the corporation pays remuneration to such person (or to any of his or her beneficiaries). This will expand the group of covered employees and cause the limit to apply to payments to former employees, which is a material change from current law.
Excise Tax on Excess Tax-Exempt Organization Executive Compensation
- A tax-exempt organization would be subject to a 20% excise tax on compensation in excess of $1 million paid to any of its five highest paid employees (each a “covered person”) for a tax year.
- Excise tax applies to all compensation (cash, cash value of non-cash remuneration (including benefits) paid to a covered person for services, excluding amounts contributed to a tax-qualified retirement plan and amounts excludable from the covered person’s gross income.
- Once an employee qualifies as a covered person, the excise tax would apply to compensation in excess of $1 million paid to that person so long as the organization pays him remuneration.
- The excise tax also would apply to excess parachute payments paid by the organization to covered persons.
- Similar to Code Section 280G, an excess parachute payment generally would be a payment contingent on the employee’s separation from service with an aggregate present value of three times the employee’s base compensation or more.
Repeal of Certain Compensation Exclusions
The House Bill would repeal the following Code Sections:
- Code Section 129: dependent care assistance programs.
- Code Section 137: adoption assistance programs.
- Code Section 217: qualified moving expense reimbursements.
- Code Section 274(j): employee achievement awards for length of service or safety achievement.
The House Bill also eliminates an employer’s ability to take a deduction for entertainment, amusement or recreation activities, which may result in significant changes to existing expense reimbursement and business development activities.
Changes to Certain Retirement Plan Provisions
- Minimum age for in-service distributions under all defined benefit plans and State and local government defined contribution plans is reduced from age 62 to 59-1/2.
- Mandates the repeal of the portion of the hardship distribution Treasury Regulation that requires a 6-month ineligibility period for deferring to a defined contribution plan after taking a hardship distribution.
- Expands the types of contribution available for hardship distributions from defined contribution plans to include earnings and employer contributions.
- Expands nondiscrimination cross-testing between an employer’s defined benefit and defined contribution plans.
- Extends the period by which an employee whose plan terminates or who separates from service while a plan loan is outstanding can roll over the loan balance to avoid the loan being taxed as a distribution until the due date for filing the employee’s tax return for that year