United States: Senate Passes Tax Cuts And Jobs Act With Changes In Employee Benefits

In the early morning hours of December 2, 2017, the Senate passed the long-anticipated tax reform legislation – the Tax Cuts and Jobs Act (the Act). The Act was previously passed in the House of Representatives on November 16, 2017 (see our prior Alert on the initial House legislation). While passage in the Senate is a significant milestone, the two differing versions of the Act will need to be reconciled by the Senate and the House in the coming weeks. Once that is completed, the Act will be presented to President Trump to sign into law. The Act represents the most significant reform of the Internal Revenue Code since the Tax Reform Act of 1986.

As with the initial House proposal, the Act passed by the Senate impacts the full scope of employer plans – including qualified retirement plans, health and welfare plans and nonqualified deferred compensation plans. This Alert will analyze the changes set forth in the Act passed by the Senate as compared to the initial legislation proposed in the House and, unless otherwise noted in the chart below, all noted changes would go into effect for taxable years beginning in 2018.

Provision Initial House Bill Senate Bill

Nonqualified Deferred Compensation (Code Section 409A)

An employee would be taxed on compensation as soon as there is no longer a substantial risk of forfeiture with regard to that compensation (including stock options). The provision would be effective for amounts attributable to services performed after 2017.

None – the changes to Code Section 409A have been deleted in their entirety. The existing nonqualified deferred compensation rules remain in effect.

Limitation on Excessive Compensation (Code Section 162(m))

The exceptions to the $1 million deduction limitation for commissions and performance-based compensation would be repealed.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.

The definition of employers subject to Code Section 162(m) extended to any employer required to file reports under section 15(d) of the Securities Exchange Act of 1934.

Same as proposed House bill, but Senate bill includes a transition rule under which the changes would not apply to compensation under a written binding contract in effect on November 2, 2017, and which was not materially modified after that date in any material aspect.

Excise Tax on Excessive 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 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.

Same as House bill.

Qualified Equity Grants

Not included in original House bill.

Allows private companies to offer certain employees the opportunity to defer income tax inclusion on compensatory stock options or restricted stock units (RSUs) for up to five years, provided certain requirements in new Code Section 83(i) are met. The company must have a written plan under which at least 80% of all employees providing services to the company in the U.S. are granted qualified stock under the provision.

The special deferral rule is not available to 1% owners, current or former CEOs and CFOs (including their family members), or certain highly compensated officers who were one of the four highest paid officers for any of the 10 preceding taxable years.

Provides for a reasonable good faith transition period for the application of the 80% and employer notice requirements.

Individual Shared Responsibility Provision ("Individual Mandate")

Not included in the original House bill.

Reduces the Affordable Care Act penalty for not purchasing creditable insurance coverage to zero, effective beginning in 2019.

Qualified Tuition Reductions

Repeal the exclusion from income for qualified tuition reductions provided by educational institutions to their employees, spouses or dependents.

None – the changes to qualified tuition reductions have been deleted in their entirety. The existing rules remain in effect.

Employer-Provided Education Assistance

Repeal the exclusion from income for employer-provided education assistance in an amount up to $5,250 per year.

None – the changes to employer-provided education assistance have been deleted in their entirety. The existing rules remain in effect.

Medical Savings Accounts

Disallow the above-the-line deduction available for contributions to Archer Medical Savings Accounts (MSAs) and the exclusion from income for employer contributions to an MSA.

None – the changes to MSAs have been deleted in their entirety. The existing rules remain in effect.

Employer-Provided Housing

Limit the exclusion for housing provided for the convenience of the employer and for employees of educational institutions to $50,000 ($25,000 for a married individual filing a joint return) and phase out for highly compensated individuals.

None – the changes to the taxation of employer-provided housing have been deleted in their entirety. The existing rules remain in effect.

Employee Achievement Awards

Repeal the exclusion from income for employee achievement awards.

None – the changes to the taxation of employee achievement awards have been deleted in their entirety. The existing rules remain in effect.

Dependent Care Assistance Programs

Repeal the exclusion from income of the value of employer-provided dependent care assistance programs up to a limit of $5,000 per year ($2,500 for married couples 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.

None – the changes to dependent care assistance programs have been deleted in their entirety. The existing rules remain in effect.

Qualified Moving Expense Reimbursement

Repeal the exclusion from income for qualified moving expense reimbursements provided by an employer.

Same as House bill, but provides exception or members of the U.S. Armed Forces on active duty who move pursuant to a military order.

Adoption Assistance Programs

Repeal the exclusion from income for adoption assistance programs that make payments of qualified adoption expenses up to certain IRS limits.

None – the changes to the taxation of adoption assistance programs have been deleted in their entirety. The existing rules remain in effect.

Re-characterization of Roth IRA Contributions

Repeal the ability of an individual to 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.

Same as House bill.

Allowable In-Service Distributions

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 59 ½.

None – the changes to in-service distributions have been deleted in their entirety. The existing rules remain in effect.

Hardship Distributions

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.

None – the changes to hardship distributions have been deleted in their entirety. The existing rules remain in effect.

Extended Rollover Period for Plan Loan Offset Amounts

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.

Same as House bill.

Modification of Nondiscrimination Rules

Expand 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.

None – the changes to nondiscrimination testing rules have been deleted in their entirety. The existing rules remain in effect.

The Act will significantly reform the Internal Revenue Code, including in the areas related to an employer's compensation and benefit plans. Some of these changes are minor, such as the removal of qualified moving expense reimbursements as a tax-free benefit. However, other changes would be extremely significant, such as the changes to the deductibility of compensation in excess of $1 million to covered employees under Code Section 162(m) and the adoption of public company-like rules for the top employees of tax-exempt organizations. With respect to tax-exempt organizations, they are encouraged to examine their current compensation programs to identify and address any issues related to the receipt of compensation in excess of $1 million in a given taxable year and any potential parachute payments in connection with a termination of employment.

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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