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Comp and Benefits Brief

November 6, 2017

Tax Reform – Does the Bell Toll for Executive Deferred Compensation?

By Susan E. Stoffer

The text of H.R.1, the Tax Cuts and Jobs Act (TCJA), was released on November 2, 2017.  If enacted, deferred compensation as we know it will effectively come to a halt. That being said, we expect that the framework of the TCJA will undergo substantial reconstruction over the next few weeks.  Below is a quick overview that illustrates the potential effect on executive compensation practices.

Comp Item

Current Law

TCJA

 

Comments

 

Stock Options

NSO taxed upon exercise; ISOs taxed upon sale after exercise – not currently taxed upon vesting

Options taxed upon vesting

Under the TCJA, an item becomes “vested” once there is no longer a substantial risk of forfeiture, with a substantial risk of forfeiture tied solely to future performance of substantial services (not an event such as a future IPO or a change in control, or a non-compete provision)

SARs

Taxed upon exercise

Taxed upon vesting

Same as above

 

Restricted Stock

Taxed upon vesting

Taxed upon vesting

No change (presumably Section 83(b) election still available)

 

Restricted Stock Units/Performance Share Units

Taxed upon vesting for FICA/FUTA,  but income tax at time of distribution (409A payment event)

Taxed upon vesting

Same concept of future performance of substantial service being the only good consideration for substantial risk of forfeiture 

 

Phantom Units

Taxed upon vesting for FICA/FUTA, but income tax at time of distribution (409A payment event)

Taxed upon vesting

Same concept of future performance of substantial service being the only good consideration for substantial risk of forfeiture

 

LLC Profits Interests

Treat as Section 83 property and with 83(b) election taxed at grant when $0 value

 

Not addressed

Remains to be seen

Change in Control Cash Bonus Plans

Vesting over time with deferred payment of the vested amount at the date of the Change in Control (a 409A payment event) results in no income taxation until payment

Taxed upon vesting

Unclear how valuation of taxable amount might be calculated

SERPs

Non-qualified retirement plans vested over time and paid out at termination of employment in installments; taxed upon receipt of payments

Taxed upon vesting

Would need to redesign to provide for vesting only on attainment of a fixed age and completion of a fixed number of years of service. If remain in employment until such time, then would be taxed. No clear method to defer the taxation beyond such point

 

Severance Commitments

Taxed upon payment

Taxed upon vesting (at termination of employment)

Will need to watch to see if use of “involuntary termination” concept is modified


Other highlights of the new proposed TCJA include the following:

  • For public companies - elimination of Code Section 162(m) performance-based compensation exception to the $1 million deduction limit (e.g., equity compensation no longer excluded); will cover CEO, CFO plus three highest paid employees (and their beneficiaries) and will apply regardless of when paid.
  • For tax-exempt organizations - application of a 20% excise tax on compensation paid in excess of $1 million to any of the five highest paid employees for the tax year.  Once an employee qualifies as being a covered person, the characterization survives so long as the organization pays him or her remuneration. In addition, a 20% excise tax will apply to any amounts paid on a separation from service with an aggregate present value equal to or exceeding three times the employee’s “base compensation.”
  • All deferred compensation previously granted or deferred must be taken into taxable income by 2026 (or if later, the year it vests).

Now, we wait and watch.