On November 9, the Senate released a detailed summary of its tax reform bill, which includes several provisions relating to compensation. The compensation provisions in the Senate Mark are very similar to those included in the final House bill, with the notable exception of the deferred compensation provision. According to the Senate Mark, the Senate bill effectively eliminates deferred compensation (including non-statutory stock options) and penalizes compensation paid to top earners at public companies and tax-exempt organizations. If enacted in the form described in the Senate Mark, the Senate bill is likely to have a dramatic impact on how companies pay their executives, directors and key employees.
Nonqualified Deferred Compensation. Current law permits employees and other service providers to defer compensation, subject to compliance with Section 409A (e.g., timely elections, payments made only on specified dates or permissible events). The Senate Mark effectively eliminates the ability to defer compensation and expands how deferred compensation is defined. The House initially included a very similar provision in its bill but has since removed the provision.
Under the Senate Mark:
- Compensation is includible in income when it is no longer subject to a substantial risk of forfeiture (SROF)—effectively on vesting—even if not payable until a future year (unless paid by March 15 of the year after the year of vesting).
- Compensation is considered subject to a SROF only if conditioned on the future performance of substantial services (neither a performance condition nor a non-compete qualifies as a SROF). In other words, the only SROF that can delay inclusion is a risk of loss of the compensation by a voluntary termination of employment.
- Stock options and SARs are specifically included in the Senate Mark’s definition of nonqualified deferred compensation. There is an exception for statutory stock options (ISOs and qualified ESPP options) for which there is no disqualifying disposition.
- The Senate Mark’s restrictions apply to compensation for services performed after December 31, 2017. Existing deferred compensation amounts are grandfathered but must be paid out before 2027 (one year later than under the original House bill).
The House bill includes a provision that allows employees of private companies who receive stock options or RSUs to defer for up to 5 years the income tax arising on exercise or settlement of the awards. This provision is not referenced in the Senate Mark.
Limit on Executive Compensation Paid by Public Companies. Section 162(m) currently imposes an annual limit of $1 million on the deductibility of compensation paid by a public company to each of its covered employees (the CEO and the three other highest paid executive officers, other than the CFO), with a similar but separate rule for emerging growth companies, unless an exception applies. The Senate Mark includes the same amendments to Section 162(m) as the House bill:
- The exceptions for performance-based compensation (including stock options) and commissions are repealed.
- The list of covered employees is expanded to include the CFO.
- An employee who is covered in one year remains covered so long as the employee receives compensation from the company (including after termination of employment).
- The deduction limit is expanded to include not only corporations issuing equity securities required to be registered under Section 12 of the Securities Exchange Act but also some companies with registered debt securities or that are not listed on an exchange but that have a large number of equity holders.
- The amendment applies to taxable years beginning after December 31, 2017.
For a more detailed summary of these amendments to Section 162(m), click here for our post summarizing the House’s version of the bill.
Limits on Compensation Paid by Tax-Exempt Organizations. Under current law, tax-exempt organizations (such as many hospitals and universities) are not subject to limits on compensation (other than the limitation on private inurement). The Senate Mark includes the same provision as the House bill that imposes a 20% excise tax on “excessive” compensation paid by tax-exempt organizations. For a summary of this provision, click here for our post summarizing the House’s version of the bill.
To help companies prepare for potential changes to compensation rules, Davis Polk has issued a memorandum with tips for planning ahead in light of compensation-related proposals in the bill. The memorandum is available here.