by James Deets
The Tax Cuts and Jobs Act of 2017 (Act), signed into law on December 22, 2017, makes substantial changes to the tax laws impacting executive compensation and employee benefits.
Compensation Limitation: Section 162(m) of the Internal Revenue Code provides that compensation exceeding $1 million paid to one of the top five executives of a publicly traded corporation is not deductible by the corporation.
Prior to the Act, the law contained an exception for “performance-based compensation.” Under this exception, assuming certain requirements were met, compensation that became payable due to the satisfaction of certain performance criteria could still be deducted even if it exceeded $1 million.
Most public companies relied heavily on this exception to deduct compensation paid to their top executives. The Act, however, eliminated the exception, so that any compensation exceeding $1 million payable to any of the top executives of a public company is no longer deductible.
While there is a grandfathering provision that exempts from the new law compensation payable under a written binding contract in effect on November 2, 2017, it is unclear how broadly the grandfathering provision will be applied, and accordingly, companies should generally expect to lose the deduction for compensation paid in excess of $1 million.
In addition to the foregoing, the Act also added a new section 4960 to the Internal Revenue Code, which imposes an excise tax of 21 percent on compensation exceeding $1 million paid to certain employees of nonprofit entities. Often dubbed the “college football coach tax,” the provision is intended to put nonprofits on the same footing as for-profit entities with respect to excessive employee compensation.
Qualified Transportation Benefits: The Act eliminated the employer deduction for qualified transportation fringe benefits provided to employees. Therefore, employers who pay for parking, or for transit passes for employees, will no longer be able to take a deduction for such expenses.
While employees may generally continue to receive tax-free reimbursement of such expenses, those who prefer to travel on two wheels will no longer enjoy tax-free reimbursement of bicycle-related commuting expenses, at least until 2027.
Tax Credit for Paid FMLA Leave: The Act provides a tax credit for employers who provide paid family and medical leave to employees. The tax credit starts at 12.5 percent of FMLA wages paid for employers who pay employees fifty percent of their normal wage during leave, and scales up to 25 percent for employers who pay full wages to employees during FMLA leave. Unfortunately, this employee-friendly provision is only effective for FMLA wages paid in 2018 and 2019.
401(k) Loan Relief: Prior to the Act, employees who terminated employment with loans outstanding under their employer’s 401(k) plan were hit with income tax, plus a 10 percent penalty tax on the loan balance—unless they could come up with funds equal to the loan balance and contribute those funds to an IRA as a “rollover” within 60 days. For many employees, the 60-day time limit that applied made this offsetting IRA contribution impossible.
Under the Act, taxpayers may now make an offsetting IRA rollover contribution at any time up until the due date (including extensions) of the tax return that relates to the year in which the termination of employment occurred. The additional time allowed to make the IRA contribution should allow many individuals who would otherwise be unable to meet the 60-day deadline to avoid the 10 percent early withdrawal penalty tax and preserve the value of their retirement savings.
Moving Expense Reimbursements: Under prior law, employees were generally able to receive tax-free reimbursement of moving expenses incurred when relocating for a new job, and companies paying employees to relocate could deduct such expenses. The Act eliminates this deduction and exclusion. Accordingly, employees who relocate should expect to be taxed on moving expense reimbursements, and may consider negotiating with their employer for a tax “gross-up” payment to offset the taxes incurred with respect to such reimbursements.
Unreimbursed Business Expenses: Under prior law, employees were generally able to take an itemized deduction for unreimbursed business expenses that exceeded 2 percent of their adjusted gross income. The Act eliminated this deduction, so that employees will no longer be able to deduct unreimbursed business expenses in any amount.
The Act constitutes a substantial overhaul of the U.S. tax laws, and includes many provisions that are not discussed here. However, this article has intended to summarize the major provisions impacting employees and executive compensation. The practical impact of the Act, and whether it will result in significant workplace changes, is yet to be seen.
James Deets is a Senior Director at Alvarez & Marsal Taxand, LLC. He can be reached at email@example.com.