2018 Tax Reform Series: Change to Employer Deduction Rules

This is the sixth article in our series covering the various tax and employee benefits-related changes contained in the Tax Cuts and Jobs Act signed by the President on December 22, 2017.

One surprising change made by the Act, summarized below, is the elimination of the employer deduction for certain settlement payments made in the employer-employee context.

General Rule

Payments made in settlement of claims or suits arising out of the employer-employee relationship are tax deductible by an employer unless the payment is specifically listed as nondeductible in the Internal Revenue Code (“Code”).

Prior to the Act, Section 162 of the Code provided that only the following types of payments were nondeductible:

  • Any punitive fine or similar penalty paid to a government for the violation of any law.
  • Any illegal payment, bribe, kickback, or rebate when made under any of the circumstances or to or by any of the persons described in the Code.
  • A portion of treble damage payments under the antitrust laws.

Limitations on Deductions Added by the Act

The Act adds two limitations to the tax deductibility of payments that can apply in the employer-employee context. In particular, the Act adds the following types of payments as nondeductible:

  1. Any settlement or payment related to sexual harassment or sexual abuse and attorney fees related to such settlement or payment IF the settlement is subject to a nondisclosure agreement.
  2. Any amount paid at the direction of a governmental entity in connection with the violation of any law or the investigation or inquiry by the governmental entity into a potential violation of law − OTHER THAN amounts paid as restitution for damages or paid to come into compliance with the law.

Both changes are effective for payments made after December 22, 2017.

Issues to Consider Regarding Nondeductibility of Sexual Abuse or Harassment Claims

  • The changes made by the Act apply only to the deductibility of the payments by the employer. The Act does not change the plaintiff’s/claimant’s tax treatment of the payments.
  • As neither the Act nor the Conference Report provide any indication as to how to answer the following questions, we will need further guidance from the IRS to answer such questions:
    • Does nondeductibility apply if the sexual abuse or harassment claim is meritless or frivolous?
    • If a claimant/plaintiff includes claims other than sexual harassment or sexual abuse, can the settlement amount be allocated among the nondeductible sexual harassment or abuse claims and the deductible other claims?
    • If the settlement amount is allocated, on what basis can the allocation be made?
    • For example, the basis for allocating a settlement amount between W-2 wages subject to withholding taxes and Form 1099 taxable income can be problematic. Both the courts and the IRS have stated that the allocation made by the parties in a settlement agreement can be ignored if the allocation does not reflect the economic substance of the claims.

Employer Takeaway

If a claimant/plaintiff includes claims other than sexual harassment or sexual abuse, we suggest that the settlement agreement designate the portion of the settlement amount (either as a percentage or a dollar amount) being allocated to the sexual harassment or abuse claims. The purpose is to provide the basis for taking the position that the portion of the payment made for the other claims is tax deductible.

If a settlement payment is made at the direction of a governmental entity in connection with the violation of any law or the investigation or inquiry by the governmental entity into a potential violation of law, the law, as revised by the Act, retains the distinction between nondeductible punitive fines and deductible compensatory penalties. The employer should consult with counsel to determine the deductibility of such payment.

2018 Tax Reform Series: New Excise Tax on “Excess” Executive Compensation Paid by Tax-Exempt Employers

This is the fifth article in our series covering the various employee benefits-related changes contained in the Tax Cuts and Jobs Act signed by the President on December 22, 2017.

Some of the most fundamental changes under the Act in the employee benefits and executive compensation arena impact executive compensation paid by tax-exempt employers and may result in the imposition of significant new excise taxes on such employers.  These changes are summarized below.

Excise Tax on “Excess” Compensation and “Excess Parachute Payments” Paid by Tax-Exempt Employers

Under the Act, starting in 2018, tax-exempt organizations are subject to a 21% excise tax on

(i) remuneration exceeding $1 million paid to a “covered employee” in a tax year, and

(ii) any “excess parachute payment” paid to a covered employee.

“Covered employee” includes any active or former employee who is one of the 5 highest compensated employees of the organization for the current tax year, or was a covered employee in any prior year beginning in 2017 (so that the “covered employee” status persists into subsequent years, meaning that a tax-exempt employer may eventually accumulate more than 5 covered employees).

“Excess parachute payments” generally refers to compensatory “parachute payments” that are contingent on a covered employee’s separation from employment and exceed the employee’s 5-year average annual compensation (the “Base Amount”), provided that the aggregate parachute payments exceed 3 times the Base Amount.  This definition is subject to some exceptions, including exceptions for payments made to individuals who are not “highly compensated employees” under Code Section 414(q) and payments for services performed by a licensed medical professional.

Remuneration is considered to be paid when the covered employee’s right to such remuneration is not subject to a substantial risk of forfeiture, so deferred compensation may fall within the scope of these rules before it is actually paid to the covered employee.

This excise tax, if applicable, is payable by the tax-exempt employer and not by the covered employee. The Act does not provide for any grandfathering of existing compensation arrangements, or any transition period.

Employer Action Items

Tax-exempt employers must (i) identify their “covered employees” for 2018 and 2017 (because, as noted above, the “covered employee” status persists into subsequent years), and (ii) review their existing executive compensation and severance arrangements (including any deferred compensation plans) to determine whether payments to any covered employee in 2018 or future years could result in the imposition of the 21% excise tax. If so, then the employer should consider potential modifications to such arrangements, or other strategies to avoid or mitigate the impact of the excise tax.

Tax-exempt employers and their counsel will also need to consider the new rules when structuring new compensation arrangements for executives. For example, an employer may consider including protective language in any new executive compensation arrangements that would allow it to unilaterally modify or reduce compensation to the extent needed to avoid the excise tax (similar clauses are already used by some taxable corporations for excise taxes under Code Section 280G, but as this new excise tax is imposed on the employer rather than the executive, it may be more difficult to negotiate a cutback where the excise tax applies).

Although the new rules are already in effect, they raise a number of compliance questions that will need to be resolved by the IRS in future guidance. Until guidance is issued, employers and their counsel will need to put forth their best efforts to interpret the Act.

2018 Tax Reform Series: Executive Compensation Changes for Publicly Held Entities

This is the fourth article in our series covering the various employee benefits-related changes contained in the Tax Cuts and Jobs Act signed by the President on December 22, 2017.

In addition to the changes we have already discussed in this blog, the Act made significant changes to the taxation of executive compensation arrangements through its amendment of Section 162(m) of the Internal Revenue Code (“Section 162(m)”).  These changes, summarized below, will require publicly held employers, and certain other companies not previously subject to Section 162(m), to revisit their executive compensation arrangements and make appropriate adjustments in 2018 and beyond.

Expansion of Application of 162(m) Limitation and Repeal of Performance-Based Compensation Exclusion

An employer generally may deduct reasonable compensation for personal services as an

ordinary and necessary business expense, however, Section 162(m) limits the deductibility of compensation paid to a covered employee of a publicly held corporation to no more than $1 million per year.

Prior to the Act, there was an exception to this rule permitting the deduction of compensation in excess of $1 million in certain cases, including where the compensation was performance-based within the meaning of Section 162(m). The Act has eliminated this exception.

In addition, the Act has expanded the definition of “publicly held corporation” for purposes of the $1 million deductible compensation limitation to include additional securities registrants and has expanded the definition of “covered employee” to include an employer’s chief financial officer and any individual who was previously a covered employee (so that the deductibility limitation continues to apply to payments made to former covered employees or their estates, even after their death).

The Act does contain a transition rule that exempts from these changes remuneration provided pursuant to a written binding contract that was in effect on November 2, 2017 and that was not modified in any material respect on or after such date.

Employer Action Items

Although the performance-based exception has been eliminated, this change presents publicly traded employers with new flexibility to be more creative in structuring their performance-based executive compensation arrangements. For example, such employers will no longer be constrained by strict requirements under the eliminated performance-based compensation exception in setting and approving performance goals and can make adjustments to performance goals at the conclusion of a performance period that increase compensation payable where appropriate.

Moreover, employers who previously granted stock options and stock appreciation rights to ensure compliance with the performance-based compensation exception may now consider replacing such awards with other forms of incentive compensation.

Employers will also need to reevaluate their performance metrics to take into account the impact of the reduction of the corporate tax rate to 21%. In some cases, performance metrics affected by this reduction may be permitted or required to be adjusted.

Additionally, employers will now have more flexibility to provide for acceleration of the payment of performance-based compensation regardless of whether performance conditions have been satisfied, such as in the case of certain involuntary terminations.

Publicly traded employers will need to conduct an inventory of their executive compensation arrangements and compensation committee charters in 2018 and thoughtfully consider, with assistance from their tax and legal counsel, what revisions may be required or appropriate given the changes made by the Act. And certain companies that have publicly traded debt and some foreign private issuers, which were not previously subject to Section 162(m), will need to determine whether the amended Section 162(m) applies to them.

Finally, employers will need to take precautions to ensure that any pre-November 2, 2017 grandfathered arrangements intended to comply with the performance-based compensation exception under Section 162(m) are not materially modified in a way that will cause them to lose their grandfathered status.

2018 Tax Reform Series: Is Your Company Eligible for a Tax Credit for Paid Leave?

Below is the third article in our series covering the employee benefits-related changes contained in the Tax Cuts and Jobs Act signed by the President on December 22, 2017.

The Act provides employers with a welcome tax credit for offering paid family and medical leave to employees – at least for 2018 and 2019. If your company voluntarily offers paid family and medical leave to rank and file employees or is considering offering such paid leave, read on!

New section 45S of the Internal Revenue Code provides a tax credit to employers that voluntarily offer up to twelve weeks of paid family and medical leave annually to qualifying employees pursuant to a written policy.  To enjoy the tax credit, the leave benefit amount need not be equal to the employee’s normal pay, but must be at least 50% of that amount.  The amount of the tax credit is 12.5% if the leave benefit amount equals 50% of normal pay.  The 12.5% credit increases incrementally (up to a maximum of 25%) to the extent the leave benefit exceeds 50% of normal pay.  A qualifying employee is one who has been employed by the employer for at least a year and who is paid no more than 60% of the “highly compensated employee” dollar amount on an annual basis (i.e., $72,000 for 2018).

To claim the tax credit, the written policy must provide full-time qualifying employees at least two weeks (annually) of paid family and medical leave and must provide part-time qualifying employees a proportionate amount of paid family leave (based on the part-time employee’s expected work hours). The policy must also specify the leave benefit (i.e., at least 50% of normal pay).  Employers that provide paid family and medical leave for employees who aren’t covered under the Family and Medical Leave Act also must include a non-retaliation provision in the policy.  Note that the credit does not apply with respect to paid leave that is mandated under state or local law.

Congress must revisit the paid leave credit in two years, so the tax credit might not motivate employers who are not already voluntarily offering paid family and medical leave to start doing so.

If you would like assistance drafting or revising your company’s paid leave policy to qualify for the tax credit, contact the Jackson Lewis attorney with whom you normally work.

2018 Tax Reform Series: Tax Law Changes to Employee Fringe Benefits

Below is the second article in our series covering the employee benefits-related changes contained in the Tax Cuts and Jobs Act signed by the President on December 22, 2017.

As discussed below, the Act makes several changes to the taxability and deductibility of employee fringe benefits beginning January 1, 2018.

The changes are somewhat arbitrary and sporadic. Basically, employer payment or reimbursement of an employee’s business expenses (so-called working condition fringe benefits) will continue to be tax-free to the employee and tax deductible by the employer.  But certain fringe benefits that still can be provided tax-free to an employee will no longer be tax deductible by the employer.  On the other hand, if an employer chooses to provide the affected fringe benefits on a taxable basis to the employee (i.e., as W-2 wages), the employer will be able claim a tax deduction for the taxable benefits.

The following is a summary of the employee fringe benefits affected by the Act.

Employees Can No Longer Deduct Unreimbursed Business Expenses

Prior to the Act, an employee who itemized tax deductions could deduct unreimbursed employee business expenses as a miscellaneous itemized deduction (to the extent that the aggregate miscellaneous itemized deductions exceeded 2% of the employee’s adjusted gross income). However, beginning January 1, 2018 miscellaneous itemized deductions are no longer allowed.  That means that if an employer reimburses an employee for a business expense, the reimbursement is tax-free to the employee.  However, if the employer does not reimburse the employee’s business expense, the employee no longer will be able to claim a tax deduction for the expense.

Moving Expenses

Prior to the Act, an individual could claim an above-the-line deduction (a non-itemized deduction) for moving expenses paid in connection with commencement of work at a new principal place of work.  Alternatively, an employer could pay or reimburse an employee for moving expenses as a tax-free fringe benefit.

Beginning in 2018, an employee can no longer deduct moving expenses nor can an employer pay or reimburse an employee’s moving expenses on a tax-free basis. On the other hand, if an employer treats payment or reimbursement of an employee’s moving expenses as W-2 wages, the employer can deduct the payment as a compensation expense.

Qualified Transportation Benefits

Prior to the Act, the value of a “qualified transportation fringe” benefit provided by an employer to an employee was treated as tax-free, subject to monthly limits. A “qualified transportation fringe” is defined as:

  • transportation in a commuter highway vehicle for travel between the employee’s residence and place of employment;
  • transit passes;
  • qualified parking; and
  • qualified bicycle commuting reimbursement.

Employers can still provide tax-free qualified transportation fringe benefits to employees (although qualified bicycle commuting reimbursements cannot be provided tax-free). However, an employer cannot deduct the expenses for providing tax-free transportation fringe benefits.

  • On the other hand, if an employer treats the transportation fringe benefits as taxable W-2 wages to the employee, the employer can deduct the expenses of providing those benefits.

Commuting Benefits

The Act provides that an employer cannot deduct any expense incurred for providing any transportation, or any payment or reimbursement, to an employee of the taxpayer for travel between the employee’s residence and place of employment, except as necessary for ensuring the employee’s safety.

In general, commuting expenses always have been treated as taxable to an employee.

Entertainment Expenses

The Act provides that an employer cannot claim a tax deduction for entertainment, amusement or recreation expenses or with respect to any facility used in connection with such activity. The Act also prohibits any deduction for amounts paid for membership in any club organized for business, pleasure, recreation or social purpose.  In contrast to prior law, it does not matter whether the expense is directly related to or associated with the active conduct of the employer’s trade or business.

Note that an employer can still fully deduct expenses for goods, services or facilities that are treated as W-2 wages to the employee. In addition, an employer can fully deduct expenses paid to reimburse an employee under a reimbursement or other expense allowance arrangement that can be treated as tax-free to the employee under the accountable plan rules.

Expenses for Employer-Operated Eating Facilities Only 50% Deductible

The Act does not change the rules for determining whether the value of meals provided to an employee at employer-operated eating facility can be treated as tax-free to the employee.

  • Section 132(e)(2) provides that the value of the meals can be tax-free if: (1) the facility is located on or near the employer’s business premises, (2) the facility’s annual revenue equals or exceeds its direct operating costs; and (3) for highly compensated employees, the facility is operated without discriminating in favor of such employees.
  • Section 119 provides the value of meals furnished to an employee can be tax-free if: the meals are provided on the employer’s business premises; and (2) are provided “for the convenience of the employer”.

However, the Act now imposes a 50% limit on deducting food or beverage expenses to employees at an employer-operated eating facility. These expenses are made fully nondeductible after Dec. 31, 2025.

Definition of Tangible Personal Property for Tax-Free Employee Achievement Awards

The Code permits an employer to make a tax-free award of tangible personal property to an employee for length-of-service or safety achievement subject to certain conditions and dollar limits.

The Act codifies the definition of “tangible personal property” (based on the proposed regulations issued in 1989) to state that tangible personal property does not include

  • cash, cash equivalents, gift cards, gift coupons, or gift certificates; or
  • vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items.

However, arrangements that confer only the right to select and receive tangible personal property from a limited array of items pre-selected or pre-approved by the employer qualify as tangible personal property.

2018 Tax Reform Series: A Change to Participant Loan Rollovers

One welcome qualified plan change under the Tax Cuts and Jobs Act is the extension of the period within which a participant may pay the amount of an “offset” of an outstanding plan loan to another qualifying plan or IRA to accomplish a tax-free rollover of the loan offset amount. The change became effective January 1, 2018.

A distribution of a plan loan offset occurs when, under the plan terms, a participant’s accrued benefit is reduced (or offset) in order to repay the loan. A distribution of a plan loan offset amount may occur in a variety of circumstances, such as where the plan terms require that, in the event of the participant’s request for a distribution, a loan be repaid immediately or treated as in default. The new rule applies to unpaid accrued loan amounts that are offset from the participant’s plan account at plan termination or at or after severance from employment if the plan provides that the accrued unpaid loan amount must be offset at such time.  Prior to this law change, the deadline to roll over the offset was the 60th day after the date the loan offset arose.  As of January 1, 2018, the deadline is the filing due date (including extensions) for the participant’s tax return for the year in which the loan offset amount arises.   As a result of this change, the loan offset rollover period can be as long as 21 months where the loan offset occurs early in the calendar year and the participant requests an extension of his or her Form 1040 deadline for the year of the offset.

The change means that a qualifying participant who desires to defer taxes on the maximum amount of distributions by rolling over all of his or her distributed account in a plan (including qualified plans such as 401(k) plans, 403(b) plans or governmental 457(b) plans) will now have significantly more time to accumulate from other sources an amount equal to the accrued and outstanding unpaid principal and interest on any plan loan that was earlier extended to him or her and treated as an offset and then pay and roll over such amount to another qualifying plan or IRA.

Note, however, that such tax-free rollover treatment does not apply to any offset amount under a loan that has already been deemed to be taxed as a distribution under the Code (and reportable on Form 1099-R) either because its terms did not comply with the Code or because it remained in default past the plan’s default cure period (which cannot be longer than the end of the calendar quarter that begins after the quarter in which the default arises). The amount of such a defaulted loan will, absent correction under the EPCRS plan correction procedures, be treated as of the end of the allowed cure period as if it were a taxable distribution from the plan that can also be subject to the 10% early distribution penalty tax.

Finally, remember that a loan offset amount is treated as both a repayment and a distribution of a plan loan amount.  Therefore, unless a deemed tax distribution (as discussed above) has occurred, the offset amount will be taxed to a participant except where an amount equal to the offset is timely rolled over tax-free by the participant.  The new liberalization of the rollover period for offsets will make possible many more such rollovers.

Employers Rejoice – IRS Announces Filing Extension for Furnishing 2017 Forms 1095-B and 1095-C and Continued Good Faith Transition Relief

In IRS Notice 2018-06, the IRS announced a 30-day automatic extension for the furnishing of 2017 IRS Forms 1095-B (Health Coverage) and 1095-C (Employer-Provided Health Insurance Offer and Coverage), from January 31, 2018 to March 2, 2018.  This extension was made in response to requests by employers, insurers, and other providers of health insurance coverage that additional time be provided to gather and analyze the information required to complete the Forms and is virtually identical to the extension the IRS provided for furnishing the 2016 Forms 1094-C and 1095-C in Notice 2016-70.  Notwithstanding the extension, the IRS encourages employers and other coverage providers to furnish the Forms as soon as possible.

Notice 2018-06 does not extend the due date for employers, insurers, and other providers of minimum essential coverage to file 2017 Forms 1094-B, 1095-B, 1094-C and 1095-C with the IRS.  The filing due date for these forms remains February 28, 2018 (April 2, 2018, if filing electronically), unless the due dates are extended pursuant to other available relief.

The IRS also indicates in Notice 2018-06 that, while failure to furnish and file the Forms on a timely basis may subject employers and other coverage providers to penalties, such entities should still attempt to furnish and file even after the applicable due date as the IRS will take such action into consideration when determining whether to abate penalties.

Additionally, Notice 2018-06 provides that good faith reporting standards will apply once again for 2017 reporting. This means that reporting entities will not be subject to reporting penalties for incorrect or incomplete information if they can show that they have made good faith efforts to comply with the 2017 Form 1094 and 1095 information-reporting requirements. This relief applies to missing and incorrect taxpayer identification numbers and dates of birth, and other required return information. However, no relief is provided where there has not been a good faith effort to comply with the reporting requirements or where there has been a failure to file an information return or furnish a statement by the applicable due date (as extended).

Finally, an individual taxpayer who files his or her tax return before receiving a 2017 Form 1095-B or 1095-C, as applicable, may rely on other information received from his or her employer or coverage provider for purposes of filing his or her return. Thus, if employers take advantage of the extension in Notice 2018-06 and receive employee requests for 2017 Forms 1095-C before the extended due date, they should refer their employees to the guidance in Notice 2018-06.


Major Changes to Executive Compensation Tax Rules Loom

On December 2, 2017, the U.S. Senate passed its version of the Tax Cuts and Jobs Act, which follows a prior passage on November 16, 2017, of a House version of the tax bill.  The bills must now be reconciled by a joint committee of House and Senate members, but both bills would make significant changes to the Internal Revenue Code rules affecting executive compensation paid by tax-exempt employers and publicly traded companies, which would require employers to review and possibly restructure their executive compensation arrangements, in some cases prior to 2018.  Read more about these changes and suggested action items for employers here.


Your Not So Kind (or Welcome) Early Holiday Gift from the IRS: Letter 226j

On more than one occasion since passing the Affordable Care Act (“ACA”), the IRS has given some type of early holiday “gift” to alleviate pending compliance concerns for employers. One of the most significant of these occurred in late December 2015, when the IRS extended the mandated filing periods for Forms 1094/1095, which gave employers more time to comply with the ACA’s new reporting obligations. Employers were still coming to grips with reporting health insurance coverages offered during the 2015 taxable year and the litany of new codes used to determine if the employer had adequately complied with Code Section 4980H’s employer shared responsibility requirements. At that same time, the IRS also communicated that employers would not be penalized for filing incorrect or incomplete Forms 1094/1095 if the forms were actually filed by the extended deadlines and filers could show they “made good faith efforts to comply with the information reporting requirements for 2015.”

It comes then as somewhat of a surprise to many that the IRS has not only moved forward with its efforts to review previously filed Forms 1094/1095, but actually has begun enforcement efforts against employers for the 2015 reporting period. However, as the IRS quietly announced would be happening through its updated Employer Shared Responsibility Question and Answer site, the IRS has now begun issuing Letter 226J (sample copy here), which is its official notification of a proposed Employer Shared Responsibility Payment (“ESRP”) assessment for alleged noncompliance with Code Section 4980H. We have now had several clients who have received their Form 226J notice and we are issuing this general response concerning what employers should do if they receive a Letter 226J for 2015 or any period thereafter.

What to Do if You Receive a Letter 226J:

• Breathe. Understand this is only a preliminary calculation of your proposed ESRP liability. Depending on the size of employer, the proposed ESRP can be significant (we have had one employer with an ESRP estimate of over $1.7 million for only 16 people who were listed as having been subject to the IRS assessment) but understand this is not an actual assessment of the amount you actually owe.
• Understand that the IRS gives each employer a full opportunity — using Form 14764 enclosed with the Letter 226J — to dispute the calculation and provide additional information for the IRS to review before issuing any further liability assessment. Given that 2015 was the first filing year for the Forms 1094/1095, it is entirely likely that one or more forms filed were not completed correctly based on IRS guidance issued thereafter.
• Don’t ignore or delay dealing with the Letter 226J you just received. Even though the IRS allows each employer to agree/disagree/or partially agree with the ESRP calculation (the employer can go ahead and make payment of any ESRP amount if it otherwise agrees to the calculated amount), the employer has a set period of time (generally 30 days) to respond or the calculated amount will be assumed correct and further assessment will be made thereafter.
• Review the list of employees included on Form 14765 to determine if they are all actually employees of your organization and gather previously filed Forms 1095-C for each individual to determine if the information provided is accurate, or if other changes need to be made in your IRS response. The IRS provides a process on the Form 14765 for further correction of any errors in original Form 1095-C filings.
• If you dispute the IRS’s ESRP calculation, prepare a Form 14764 with a statement to explain your reasons for disagreeing with the IRS ESRP calculation. Supporting documentation should be included to evidence the reasons for disputing the IRS calculation, such as any written documentation of any prior offer of qualifying coverage.
• Remember that if you filed Forms 1094/1095 for more than one entity (such as multiple subsidiaries or other controlled group members), it is entirely possible the IRS will issue separate Letter 226Js for each entity and you need to ensure that all organizations know and understand the timing and compliance responsibility owed to the IRS for each other entity.
• Understand that you can appoint Jackson Lewis or another representative to assist you in discussing the matter further with the IRS, including engaging in further discussions with the IRS without any admittance of liability on your part.

The vast majority of situations where ESRP liability will be assessed will be those situations where the IRS had incorrect or incomplete information to review. Our role is to ensure that our clients are adequately informed and represented to ensure that the IRS has correct information that evidences compliance with all employer shared responsibility requirements, or if not, to assist in mitigating the impact of any noncompliance in the manner necessary. Meanwhile, continue with efforts to comply with Form 1094/1095 filing requirements for the 2017 taxable year, as it appears the IRS will continue its current objective of holding employers accountable to their ACA shared responsibilities for the foreseeable future. We want to ensure our clients avoid receiving other Letter 226Js to the extent possible for those periods.

The Proposed Tax Cuts and Jobs Act Would Make Sweeping Changes to Executive Compensation and Employee Benefits

On November 2, 2017, the U.S. House of Representatives unveiled the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”) as part of proposed tax reform legislation. The Bill is sweeping in scope and provides for significant changes to the U.S. Internal Revenue Code (the “Code”), including in the area of executive compensation and employee benefits.

Executive Compensation

The Bill makes far-reaching changes in the executive compensation arena, which would curtail employees’ ability to defer taxation of compensation and incentive awards (other than under a tax-qualified retirement plan) and employers’ ability to provide fully tax-deductible compensation to their executives. If enacted in its current form, it will require fundamental rethinking and restructuring of many present-day incentive compensation packages.  Some highlights of the Bill are as follows:

  1. The Bill requires that nonqualified deferred compensation (which under the Bill includes stock options and stock appreciation rights which are generally excluded from such definition under current guidance) attributable to services performed after 2017 be subject to income tax when it is no longer subject to a substantial risk of forfeiture (i.e., when it vests, rather than when it is subsequently paid, as is currently permitted under Code Section 409A). For this purpose, only a condition requiring the future performance of substantial services will generally constitute a substantial risk of forfeiture. The Bill “grandfathers” existing nonqualified deferred compensation arrangements until 2025, at which time they will also become subject to the foregoing rules. Note that an amendment to the Bill released by the House Ways and Means Chairman Kevin Brady includes a watering-down of some of these requirements as it provides that certain employees of non-public companies who receive stock options or restricted stock units as compensation for the performance of services may elect to defer recognition of income for up to 5 years.
  2. The Bill greatly expands the reach of Code Section 162(m) (which denies a corporate deduction for compensation in excess of $1 million paid to certain top executives of publicly traded companies) by eliminating current exceptions from this rule for performance-based compensation and broadening its application in various other respects.
  3. The Bill also imposes an excise tax on compensation in excess of $1 million paid by tax-exempt employers to their five highest paid employees, as well as on certain payments contingent on separation from employment paid to such employees.

Employee Benefits

Though relatively less sweeping, the Bill also makes various changes to the current tax rules governing various employee benefit arrangements (and a number of these changes are beneficial to employees):

  1. The Bill removes taxpayers’ ability to change the tax characterization (Roth or traditional) of their contributions to individual retirement accounts (IRAs).
  2. The Bill reduces the age at which in-service distributions are permitted under defined benefit plans (as well as certain state and local government plans) from age 62 to age 59 ½.
  3. The Bill makes various changes to the rules governing participant hardship distributions under retirement plans, which would likely have the effect of facilitating larger and more frequent hardship distributions.
  4. The Bill extends the deadline for individuals who leave employment, or whose plan terminates while they are employed, to roll over their outstanding plan loan balances to an IRA in order to avoid adverse tax treatment.
  5. The Bill grants relief from nondiscrimination testing and certain other qualification requirements for some defined benefit retirement plans.
  6. The Bill limits the deductibility or exclusion of certain employer-provided fringe benefits.
  7. The Bill eliminates dependent care assistance programs, although a recent amendment to the Bill would continue the exclusion for up to $5,000 of employer-provided dependent-care assistance through Dec. 31, 2022.

If the Bill were to be passed in current form, the foregoing changes would generally apply to taxpayers beginning in 2018. However, as the Bill progresses through Congress, we expect that these provisions will undergo further revision and evolution.  Although it is too early to speculate about the final form of the Bill, it could ultimately require employers to perform a comprehensive review and restructuring of their executive compensation practices and benefit plans.

We will provide further updates as this legislation develops.