United States: Tax Reform And Employee Benefits – What You Need To Know Now

As you have probably heard by now, the recently enacted Tax Cuts and Jobs Act (the Tax Reform Act) made significant changes to the Internal Revenue Code. With regard to executive compensation, the Tax Reform Act made widely publicized changes impacting public companies and nonprofit entities. The new law also made changes affecting employer-provided retirement, welfare, and fringe benefits.

Nearly all employers, including publicly held, private, and nonprofit, need to understand what is required by the new rules. To get started, here is our list of the Top Three Things to Know Now.

1. Public Company Executive Compensation Rules Have Changed.

Code Section 162(m) imposes a $1 million deduction limit on most compensation payments made by a publicly traded employer to its covered employees in a particular fiscal year. Publicly traded employers generally spend a lot of time ensuring compliance with this rule, especially ensuring that a significant portion of the compensation paid to covered employees qualifies as "performance-based compensation." That is because, before the Tax Reform Act, performance-based compensation was excluded from the $1 million calculation and thus was fully deductible no matter the amount. The Tax Reform Act has made three significant changes for compensation paid for fiscal years that begin January 1, 2018, or later:

  • Changing the definition of "covered employee" – A "covered employee" will now be anyone who has ever been the CEO, CFO or one of the three most highly compensated officers, starting with the fiscal years beginning after December 31, 2016. Thus, the new rule is essentially "once a covered employee, always a covered employee."
  • Eliminating the exception for performance-based compensation – Performance-based compensation is no longer exempt from the $1 million deduction limit. Thus, all performance-based compensation, including performance share units, stock options and annual bonuses, will now be subject to the $1 million deduction limitation, unless grandfathered (as explained below).
  • Expansion of entities subject to Code Section 162(m) – Application of the rule is no longer limited to corporations that issue a class of common equity securities required to be registered under Section 12 of the Securities Exchange Act. The rule now also covers entities required to file pursuant to Section 15(d) of the Securities Exchange Act.

Note, however, that the changes described above do not apply to remuneration paid pursuant to a "grandfathered" arrangement, which is defined as a written binding contract that was in effect on November 2, 2017, and has not been modified in any material respect on or after such date.

More detail on these rules is discussed in the newsletter published by our Executive Compensation team and will be covered in an upcoming webinar on January 16 ( Register Here).

2. There are Big Changes to Executive Compensation Rules Applicable to Nonprofit Entities.

As a result of the Tax Reform Act, recruiting and retaining executive talent will be more costly for nonprofit entities. Specifically, beginning in 2018, nonprofit entities will be subject to limitations (and penalties) similar to those faced by publicly held companies under Code Section 162(m) and Code Section 280G:

  • An annual 21 percent excise tax will be imposed on a nonprofit employer with respect to current and vested deferred compensation in excess of $1 million paid to the entity's five highest paid employees (covered employees). As with the new rules under Code Section 162(m), once an employee is treated as a covered employee for this purpose, he or she will remain in the covered group – "once a covered employee, always a covered employee."
  • In addition, a 21 percent employer excise tax will apply if a nonprofit employer pays "parachute payments," which generally refer to payments that are triggered by a covered employee's separation from employment and exceed three times the employee's average compensation over the most recent five years. Note, however, that the excise tax itself will be imposed with respect to compensation that exceeds one times the employee's five-year average compensation (similar to Code Section 280G).

While certain exceptions could apply, the Tax Reform Act's new changes may put nonprofit entities at a disadvantage vis-à-vis for-profit companies when recruiting and retaining top talent.

More detail on the new excise tax, along with other Tax Reform Act changes that will affect nonprofit employers, will be covered in an upcoming webinar on January 17 ( Register Here).

3. The Changes to Retirement, Welfare, and Fringe Benefit Rules Are Less Significant Than Expected.

Although there was a lot of press coverage about potential changes impacting employer-provided retirement, welfare, and fringe benefits, the reality is that the final version of the law did not make any sweeping changes in this area. For example, there will not be a mandatory "Rothification" of retirement plan contributions, dependent care flexible spending accounts will not be eliminated, and the employer shared responsibility provisions under the Affordable Care Act (ACA) are still in effect.

Notwithstanding that this was much ado about (almost) nothing, nearly all employers, including public, private, and nonprofit, should note that the following changes were made

  • Individuals now have more time to make loan offset deposits to IRAs and eligible retirement plans;
  • Certain retirement plan withdrawals received in connection with a qualifying 2016 disaster are eligible for additional relief;
  • The ACA's individual mandate is effectively eliminated; and
  • There are new limitations on the tax treatment of certain employee fringe benefits.

More detail on these rules is discussed in the newsletter published by our Employee Benefits team.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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