On December 15, the Conference Committee reconciling the House and Senate tax reform bills released its full bill text to be voted on by both chambers of Congress and, if approved, presented to the President. The compensation provisions in the final bill are substantially the same as those in the Senate bill. The most important of these provisions are as follows:
Deduction Limit on Executive Compensation Paid by Public Companies.
The final bill makes the following changes to Section 162(m):
- The exceptions for performance-based compensation (including stock options) and commissions are repealed.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 bill expands the deduction limit to include not only companies issuing equity securities required to be registered under Section 12 of the Securities Exchange Act but also certain companies with registered debt securities or that do not have securities listed on an exchange but have a large number of equity holders.
The final bill includes the same grandfather provision that was included in the Senate bill: compensation is not subject to the new rules if it would have otherwise been deductible under the current Section 162(m) rules when paid and it is payable pursuant to a written binding contract that was in effect on November 2, 2017 and that is not materially modified thereafter. We expect that an analysis of whether an arrangement qualifies as a “written binding contract” will require a case-by-case consideration, but the Joint Explanatory Statement released by the Conference Committee along with the full bill text provides some guidance:
- a plan in effect on November 2, 2017 is not by itself sufficient to qualify for the written binding contract exception;
- a written plan may qualify for the grandfather if it meets certain requirements, including that the amounts payable under the plan are not subject to discretion, and that the employer does not have the right to terminate or materially amend the plan (except on a prospective basis for future service periods); and
- a written binding contract that is renewed after November 2, 2017 ceases to qualify for the exception.
Deferral of Tax on Private Company Stock Options and RSUs. The final bill allows employees of certain private companies to elect to defer the taxation of stock options and restricted stock units (“RSUs”) for up to five years after exercise of the options or settlement of the RSUs. Nearly identical provisions were included in the House and Senate bills.
For a detailed summary of this provision, click here for our post summarizing the House’s version of the provision.
Limits on Compensation Paid by Tax-Exempt Organizations. The final bill (like the House and Senate bills) imposes a 20% excise tax on tax-exempt organizations for “excessive” compensation paid to their five highest paid employees. The excise tax applies to annual compensation above $1 million paid to any of these employees and to severance and other termination-related payments that have an aggregate present value of at least three times the employee’s annual base compensation.
For a summary of this provision, click here for our post summarizing the House’s version of the provision.
Employer FMLA Credit. The final bill (like the Senate bill) allows employers to claim a general business credit equal to 12.5% of wages paid to qualifying employees on family and medical leave (FMLA), if the employees are paid at least 50% of their normal wages. The credit is increased by 0.25% for each percentage point by which the payment rate exceeds 50% (with a cap of 25% of wages paid).
Corporate Rate and AMT. In addition to the compensation-specific provisions summarized above, the final bill makes the following changes that may impact compensation:
- The final bill reduces the corporate tax rate from 35% to 21%, effective as of January 1, 2018 (rather than January 1, 2019, as in the Senate bill). Companies therefore have very little time to assess potential planning opportunities, such as whether to accelerate compensation into 2017 to allow such compensation to be deducted at this year’s higher rate.
An employee who holds an incentive stock option (ISO) that meets the ISO requirements pays capital gains tax on any increase in the share price from grant of the ISO to sale of the shares received on exercise. However, because ISOs are subject to the alternative minimum tax (AMT) on exercise, the employee may nevertheless be taxed on the spread at exercise. For this reason (among others), many companies do not grant ISOs. The final bill temporarily increases the individual alternative minimum tax (AMT) exemption amount by about 29% over current law levels and the exemption amount phase out thresholds, which could temporarily reduce AMT liability relative to applicable law for some taxpayers. Companies therefore may wish to reassess whether to grant ISOs.