United States: Impact Of The Tax Cuts And Jobs Act On Employee Benefits

On November 2, 2017, the U.S. House of Representatives Committee on Ways and Means unveiled its long-anticipated tax reform legislation – the Tax Cuts and Jobs Act (the "Act"). In addition to containing a number of high-profile changes to the Internal Revenue Code (such as changes to individual income tax rates and the mortgage interest deduction), the Act also contains a number of changes that will impact the compensation and benefit plans of employers.

The proposed changes would impact the full scope of employer plans, including qualified retirement plans, health and welfare plans, and nonqualified deferred compensation plans. This Alert will analyze the proposed changes and, unless otherwise noted in the chart below, all noted changes would go into effect for taxable years beginning in 2018.

Provision Current Law Proposed Changes
Nonqualified Deferred Compensation (Code Section 409A) Subject to compliance with Code Section 409A, nonqualified deferred compensation is not taxable until the year received – and the employer's deduction is also delayed until that time. This is true even if the deferred compensation is vested and no longer subject to a substantial risk of forfeiture. An employee would be taxed on compensation as soon as there is no longer a substantial risk of forfeiture with regard to that compensation. The provision would be effective for amounts attributable to services performed after 2017. The current Code Section 409A rules would continue to apply to existing nonqualified deferred compensation arrangements until the last tax year beginning before 2026, when such arrangements would become subject to the provision.
Limitation on Excessive Compensation (Code Section 162(m)) A corporation generally may deduct compensation expenses as an ordinary and necessary business expense. The deduction for compensation paid or accrued with respect to a "covered employee" of a publicly traded corporation, however, is limited to no more than $1 million per year. The limitation applies to all remuneration paid to a covered employee, subject to several significant exceptions: (1) commissions, (2) performance-based remuneration, including stock options, (3) payments to a tax-qualified retirement plan and (4) amounts that are excludable from gross income.

For IRS purposes, a covered employee is defined as the principal executive officer and the three highest compensated officers as of the close of the tax year.
The exceptions to the $1 million deduction limitation for commissions and performance-based compensation would be repealed.

The definition of "covered employee" would include the CEO, the chief financial officer and the three highest paid employees.

In addition, once an employee qualified as a covered employee, the deduction limitation would apply to that individual so long as the corporation continues to pay remuneration.
Excise Tax on Excessive Tax-Exempt Organization Executive Compensation While the Code limits (1) the deduction for publicly traded corporations for compensation paid to covered employees to no more than $1 million per year under Code Section 162(m) and (2) the deductibility of certain severance-pay arrangements under Code Section 280G, no parallel limitations apply to tax-exempt organizations with respect to executive compensation and severance payments. 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 for the tax year. The excise tax would apply to all remuneration paid to a covered person for services, except for payments to a tax-qualified retirement plan and amounts that are excludable from the executive'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 continues to pay remuneration.

The 20% excise tax would also apply to excess parachute payments paid to such covered persons. Under the proposal, an excess parachute payment generally would be a payment contingent on the employee's separation from employment with an aggregate present value of three times the employee's base compensation.
Qualified Tuition Reductions Qualified tuition reductions provided by educational institutions to their employees, spouses or dependents are excluded from income. The exclusion for qualified tuition reduction programs would be repealed.
Employer-Provided Education Assistance Employer-provided education assistance is excluded from income in an amount up to $5,250 per year. The exclusion for employer-provided education assistance programs would be repealed.
Medical Savings Accounts Above-the-line deduction available for contributions to Archer Medical Savings Account (MSA) and exclusion from income for employer contributions to an MSA. No deduction allowed for MSA contributions and employer contributions would not be excluded from income.
Employer-Provided Housing Housing and meals provided to an employee for the convenience of the employer are excluded from income if the meals are on the business premises of the employer and the employee is required to accept lodging on the premises of the employer as a condition of employment. The exclusion for housing provided for the convenience of the employer and for employees of educational institutions would be limited to $50,000 ($25,000 for a married individual filing a joint return) and would phase out for highly compensated individuals.
Employee Achievement Awards Employee achievement awards are excluded from income, provided they are given in recognition of length of service or safety achievement at a ceremony that is a meaningful presentation. Such employee achievement awards would constitute taxable compensation to the recipient.
Dependent Care Assistance Programs The value of employer-provided dependent care assistance programs are excluded from employees' income up to a limit of $5,000 per year ($2,500 for married filing separately) to help pay for work-related expenses of caring for a child under the age of 13 or spouses or other dependents who are physically or mentally unable to care for themselves. The exclusion for dependent care assistance programs would be repealed.
Qualified Moving Expense Reimbursement Qualified moving expense reimbursements provided by an employer are excluded from the employee's income. The exclusion for qualified moving expense reimbursements would be repealed.
Adoption Assistance Programs Adoption assistance programs that make payments of qualified adoption expenses from an employer to an employee are excluded from the employee's income up to certain IRS limits. The exclusion for payments under adoption assistance programs would be repealed.
Re-characterization of Roth IRA Contributions An individual may re-characterize a contribution to a traditional IRA as a contribution to a Roth IRA (and vice versa). The deadline is generally October 15 of the year following the conversion. The rule allowing re-characterization of IRA contributions and conversions would be repealed.
Allowable In-Service Distributions Defined contribution plans generally are not permitted to allow in-service distributions if the employee is less than 59½ years old. For defined benefit plans (as well as state and local government defined contribution plans), the restriction applies if the employee is less than age 62. All defined benefit plans, as well as state and local government defined contribution plans, would be permitted to make in-service distributions beginning at age 59½.
Hardship Distributions Treasury regulations require that plans not allow employees taking hardship distributions to make contributions to the plan for six months after the distribution.

Hardship distributions may be allowed only for amounts actually contributed by the employee and may not include account earnings or amounts contributed by the employer.
The IRS would be required within one year to change its guidance to allow employees taking hardship distributions to continue making contributions to the plan.

Employers may choose to allow hardship distributions to also include account earnings and employer contributions.
Extended Rollover Period for Plan Loan Offset Amounts If a plan terminates or an employee's employment terminates while a plan loan is outstanding, the employee has 60 days to contribute the loan balance to an IRA, or the loan is treated as a distribution (subject the 10% penalty for early withdrawals). Employees whose plan terminates or who separate from employment while they have plan loans outstanding would have until the due date for filing their tax return for that year to contribute the loan balance to an IRA in order to avoid the loan being taxed as a distribution.
Modification of Nondiscrimination Rules For employers sponsoring both a defined contribution plan and a defined benefit plan, the nondiscrimination rules allow limited cross-testing between the two plans. However, some employers who allow current workers to continue to accrue benefits but have closed their defined benefit plan to new employees come to violate the nondiscrimination rules. Expanded cross-testing between an employer's defined benefit and defined contributions would be allowed for purposes of the nondiscrimination rules, effective as of the date of enactment.

As we saw with the various pieces of legislation that the House of Representatives introduced with respect to healthcare reform earlier this year, the introduction of the Act by no means guarantees that the above summarized provisions will go into effect. However, the Act does show that significant changes will be necessary to an employer's compensation and benefit plans if tax reform is ultimately signed by President Trump. Some of the these changes would be minor, such as changes to the hardship rules under a company's 401(k) plan; however, other changes would be extremely significant, such as the changes to nonqualified deferred compensation and the adoption of public company-like rules for the top employees of tax-exempt organizations.

Attorneys in the Employee Benefits and Executive Compensation Practice Group at Duane Morris will continue to monitor these tax reform developments and assist employers with respect to any changes necessary.

For Further Information

If you have any questions about this Alert, please contact any of the attorneys in our Employee Benefits and Executive Compensation Practice Group or the attorney in the firm with whom you are regularly in contact.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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