The tax reform act passed at the end of 2017 includes important new rules governing executive compensation rules and employee benefits. With many of the provisions slated to go into effect during this calendar year, now is the time to understand how the rule will affect you.
HR consultant Rob Thurston details the impact of the new tax act on executive compensation—both this year and beyond—in a conference for Eli Financial titled, “2018 Tax Reform: Executive Compensation for Large and Small Employers.” Thurston outlines what’s included in the rules, explains when/if you need an attorney to help you comply, and discusses how to set employees’ compensation expectations.
What to Except: Lower Taxes & Changes to Stock-Option Compensation
The act signed by Donald Trump includes a number of key provisions, noted business advisors WillisTowersWatson.
- The act eliminates exceptions for performance-based compensation and commissions from the $1 million deduction limit under Internal Revenue Code Section 162(m).
- The Affordable Care Act penalty for not complying with the individual mandate is gone as of 2019.
- Tax-exempt organizations will pay a 21 percent tax on compensation greater than $1 million paid to the top five highest-paid employees, and the tax also applies to parachute payments.
- Some employees who exercise stock options as compensation may defer recognizing the income for up to five years if the stock is not tradable on an established stock market.
- Taxes on stock compensation paid to insiders in expatriated companies goes up from 15 percent to 20 percent for companies that expatriate after the bill was signed.
Of the many changes the new law entails, one overall theme is that constraints put on publicly-traded firms with respect to compensation are now similar to those for tax-exempt organizations, noted a law alert from the Wager Law Group in Boston.
“Although it could have been worse based upon the Senate proposals for tax reform, tax-exempt institutions took two major hits under the Act,” the alert stated. “The first is the 1.4% excise tax on the endowment funds of certain private colleges and universities – a controversial measure, but one that by its very nature affects a limited number of entities. The second is a more wide-ranging provision: the new section 4960 to the Internal Revenue Code, Tax on Excess Tax-Exempt Organization Executive Compensation.”
Do This: Revise Compensation Packages for New Reality
The Society for Human Resource Management suggests that companies impacted by these new provisions take a number of steps:
- Review compensation arrangements and consider if any changes should be made, including the addition of protective language in new executive compensation plans that would allow companies to modify compensation to avoid the new taxes.
- Consider accelerating bonus deductions. Because the act provides for a 21-percent corporate tax rate, down from the current 35 percent, deductions made in 2017, which can be made by March 15, are worth more than those under the 2018 tax plan.
- Consider changing performance goals.
- Plan how new paperwork and administrative burdens will be handled.
- Explore options for grandfather relief.
Catch up: Changing performance goals is key, as many companies made their standards for the current year under the old tax structure and without an assumption that the rules would change.
“In the past, annual bonus programs and long-term equity-based performance programs had to be very objective, formulaic, and mechanical to comply with the Section 162(m) exception,” Bloomberg noted. “Now, companies may have slightly more subjective performance goals.”
Thurston added that, while these changes are being considered, you also need to look ahead to what the new tax act will have in store for 2019 and beyond – especially when it comes to reformations to health care. No matter what you decide to do, knowing your options and knowing them ahead of time is critical.