Tax reform s major impact on compensation & benefits

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1 Tax reform s major impact on compensation & benefits Original Publication Date: January 10, 2018 CPE Credit is not available for viewing archived programs Please disable pop-up blocking software before viewing this webcast

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4 Speakers Eddie Adkins Partner, Human Capital Services, Washington National Tax Office Jeff Martin Partner, Human Capital Services, Washington National Tax Office Mark Ritter Managing Director, Human Capital Services Grant Thornton LLP. All rights reserved. 4

5 Learning objectives Identify the tax consequences to employers and employees regarding new rules surrounding fringe benefits Interpret the impact of changes to the 162(m) $1M deduction limit for public companies, including transition relief Analyze a new opportunity to defer taxation on stock options and restricted stock units Appraise the impact on tax-exempt organizations, including the 21% excise tax on highly compensated employees 5 Plan for new income tax withholding rates Grant Thornton LLP. All rights reserved. 5

6 Tax reform H.R. 1, commonly referred to as Tax Cuts and Jobs Act ("TCJA") Signed into law on December 22, 2017 Sweeping overhaul of business and individual taxes Many changes go into effect for taxable years beginning after December 31, 2017 Individual tax changes generally sunset in 2026 Business changes are generally permanent Grant Thornton LLP. All rights reserved. 6

7 Agenda 1 Executive compensation 2 Fringe benefits 3 Retirement plans 4 Income tax withholding 5 Tax credit and individual mandate Grant Thornton LLP. All rights reserved. 7

8 Section 162(m) - $1M limit Prior law Limits a public corporation's deduction to $1M per covered employee per year Qualified performance-based compensation and commissions exempt from the limit Four (max) covered employees per year: CEO as of the last day of the taxable year Three highest paid officers other than the CEO and CFO serving on the last day of the taxable year Based on SEC proxy disclosure rules CFO's compensation was not subject to the $1M limit Grant Thornton LLP. All rights reserved. 8

9 Section 162(m) - $1M limit No exception for performance-based compensation and commissions Changes under TCJA Expands definition of covered employee Expands the definition of publicly traded corporation General effective for taxable years beginning after December 31, 2017 Grant Thornton LLP. All rights reserved. 9

10 Section 162(m) Compensation subject to the $1M deduction limit All deductible compensation for services is subject to the $1M limit No exception for qualified performance-based compensation or commissions Certain existing exceptions still apply: Contributions to and distributions from a qualified retirement plan Amounts reasonably expected to be excludible from the covered employee's gross income Grant Thornton LLP. All rights reserved. 10

11 Section 162(m) Public corporation Definition is expanded to include: Foreign corporations publicly traded through American depository receipts Private corporations and S corporations required to file reports under section 15(d) of the Exchange Act Includes corporations that have issued equity or debt securities to the public in a registered offering but has not listed on a securities exchange Grant Thornton LLP. All rights reserved. 11

12 Section 162(m) Covered employee new definition CEO and CFO at any time during the taxable year (not just the last day) Three highest paid officers serving of the last day of the year other than the CEO and CFO (determined under SEC proxy disclosure rules) If an individual is a covered employee in any tax year beginning after December 31, 2016, he or she is a covered employee in all future years Impact: Possibly more than five covered employees in a given year Amounts paid to a covered employee in or after year of termination is subject to the limit (including payments after death) Grant Thornton LLP. All rights reserved. 12

13 Section 162(m) transition relief All changes to the law do not apply to written binding contracts in effect on November 2, 2017 Applicable qualified performance-based compensation is exempt even if paid in 2018 or a future year For the applicable contract, prior covered employee and public corporation definitions apply E.g., deferred compensation paid in or after the year of termination is not subject to the $1M limit because the employee is not a covered employee Transition relief expires when the plan or agreement is materially modified Grant Thornton LLP. All rights reserved. 13

14 Section 162(m) transition relief No guidance yet consider Joint Committee on Taxation explanation Example in the JCT explanation states a plan is eligible for the transition relief if: Plan is in writing Executive is eligible to participate in the plan, even if not actually participating in the plan on November 2, 2017 Amount payable is not subject to discretion The corporation does not have the right to amend or terminate the plan, except prospectively for services not yet provided Grant Thornton LLP. All rights reserved. 14

15 Section 162(m) transition relief No guidance yet consider Joint Committee on Taxation explanation (continued) Plan is treated as renewed if either party can terminate or cancel the plan at will without the other party's consent Does not apply if the employee's employment must also be terminated Transition relief guidance may be similar to existing Treas. Reg (h) Transition relief when section 162(m) was enacted Grant Thornton LLP. All rights reserved. 15

16 Section 162(m) unanswered questions Will any discretion to change the amount of payment under a plan disqualify the plan from the transition relief? How does the transition relief apply to benefits accrued under a plan on November 2, 2017 if the plan can be terminated by the company without affecting accrued benefits? What is a material modification to a plan? Grant Thornton LLP. All rights reserved. 16

17 New opportunities Elimination of performance-based compensation exception may impact incentive plan design Current law requirements for exception Performance criteria must be completely objective Compensation committee may not exercise discretion to increase the compensation above amount or formula specified in advance Compensation payable solely upon satisfying time-based vesting requirement does not qualify for the exception Potential impact when exception eliminated Subjective criteria may be included in establishing performance goals (e.g., obtaining an overall performance rating of "outstanding") Compensation committee may choose to pay higher amount (e.g., for outstanding performance) More freedom to use time-based vesting (e.g., restricted stock granted without regard to satisfying performance conditions, with vesting contingent only upon remaining with the company for a specified period) Grant Thornton LLP. All rights reserved. 17

18 Other changes to plan design Change Deduction limited to $1 million, regardless of pay mix Once a covered employee, always a covered employee Potential impact on plan design Reduction in historical compensation amounts to reflect loss of tax deduction (but reduction amount may be small or $0 due to need to attract and retain executives) Spread out post-employment payments, such as deferred compensation, so that payments do not exceed $1 million per year Grant Thornton LLP. All rights reserved. 18

19 Section 162(m) Action plan Consider whether existing compensation plans are eligible for the transition relief Identify all covered employees from tax years beginning in 2017 and going forward Determine whether your private company is subject to section 162(m) Tax accounting: Consider whether adjustments must be made to existing deferred tax assets Consider the impact on the company's effective tax rate Grant Thornton LLP. All rights reserved. 19

20 Qualified equity grants TCJA adds section 83(i) Available only to private companies Allows an election to defer recognition of income up to five years Certain individuals (e.g., highly paid) are not eligible Grants must be made to at least 80% of fulltime U.S. employees (broad-based grants) Also defers the employer's deduction Applicable to options exercised, or restricted stock units settled, after December 31, 2017 Qualified equity grants [Icon here] Stock options Lorem [Icon here] Restricted stock units Grant Thornton LLP. All rights reserved. 20

21 General tax rules for stock options and restricted stock units Nonqualified stock options No income upon grant or vesting Income is recognized on the exercise date Income = fair market value ("FMV') of the stock on the exercise date, less the exercise price Increase (decrease) in value of stock after exercise is capital gain (loss) Restricted stock units ("RSUs") No income upon grant or vesting Income is recognized upon settlement (i.e., when stock or cash is transferred to the holder) Income = FMV of stock on the transfer date or amount of cash paid Increase (decrease) in value of stock after settlement is capital gain (loss) Grant Thornton LLP. All rights reserved. 21

22 Qualified equity grants If election is made within 30 days after the right to the stock becomes vested: Amount of compensation is measured and locked in on the date the right to the stock becomes vested (FMV of stock on vesting date minus amount paid) But compensation recognition for income tax purposes is deferred to the earliest of the following dates: Five years from the date the right in the stock becomes vested The stock becomes transferrable (including to the employer) The stock becomes publicly traded The employee becomes an "excluded employee" The employee revokes the election Grant Thornton LLP. All rights reserved. 22

23 Corporate eligibility requirements Corporation may never have been publicly traded Includes predecessor corporations Determined based on controlled group Grants made to at least 80% of U.S. full-time controlled group employees All recipients must receive the same type of award Grants must have the same rights and privilages Grant must be more than de minimis, but amounts can vary Full-time = average 30 or more hours a week "Excluded employees" not counted in 80% requirement Notice requirements Stock is not eligible if immediately upon vesting in the right to the stock the employee can sell the stock to the company or settle the award in cash Grant Thornton LLP. All rights reserved. 23

24 Excluded employees May not make the election Individual who has ever been the CEO or CFO Includes their family members Any individual if, within the current or last ten years: The individual owned more than 1% of the employer (including family) Was one of the four highest paid employees Grant Thornton LLP. All rights reserved. 24

25 Qualified equity grants requirements Employee must agree to comply with withholding rules Income tax withheld at the highest marginal rate (currently 37%) Form W-2 reporting requirements (disclosures only) Amount excluded from income in year of the election Amount included in income in the last year of deferral Aggregate amount currently deferred under all active elections May make the election on incentive stock options ("ISOs") and employee stock purchase plan ("ESPP") awards If election is made, loss of special tax treatment of ISOs and ESPP Grant Thornton LLP. All rights reserved. 25

26 Qualified equity grants Considerations Does making grants to at least 80% of U.S. full-time employees fit the company's compensation objectives? How does the deferred deduction affect cash flow? How does the company meet the 37% federal income tax withholding requirement? The compensation amount is locked in on the vesting date. Any decrease in stock value through the end of deferral period does not reduce compensation Employees will have to be educated about the election Grant Thornton LLP. All rights reserved. 26

27 Tax-exempts: excise tax on executive compensation new section % excise tax Compensation in excess of $1M Excess parachute payments Grant Thornton LLP. All rights reserved. 27

28 Tax-exempt organizations Who is subject to the excise tax? The tax-exempt organization pays the excise tax Tax-exempt organization includes: Organizations exempt from tax under section 501(a) A farmer's cooperative (section 521(b)(1)) Organization with income exempt from tax under section 115(1) Likely meant to include state and local government agencies A political organization (section 527(e)(1)) Grant Thornton LLP. All rights reserved. 28

29 Covered employee Any individual among the top five highest compensated employees of the organization for the year Any individual who was a covered employee of the organization for any preceding taxable year beginning after December 31, 2016 Must look back to the year before the excise tax is applicable Must consider whether the employee was a covered employee of any "predecessor" Once a covered employee, always a covered employee, even after termination of employment Not required to be an officer Exception: do not include compensation paid to a licensed medical professional which is for the performance of medical or veterinary services when determining covered employees Grant Thornton LLP. All rights reserved. 29

30 Excise tax on compensation > $1M Compensation: Wages subject to income tax withholding Form W-2, box 1 Exclude designated Roth contributions Include deferred compensation at the time of vesting (section 457(f)) Include all compensation from "related persons and governmental entities" Unclear how "related person" will be defined Exclude compensation paid to a licensed medical professional which is for the performance of medical or veterinary services Grant Thornton LLP. All rights reserved. 30

31 Excess parachute payments Step one Step two Step three Step four Determine parachute payments Base amount Threshold test Amount of excess parachute payment Any payment contingent on seperation from employment Employee's average annual compensation over the five years prior to the year of termination Excess parachute payments exist if total present value of parachute payments equals or exceeds three times the base amount Excess parachute payment subject to the excise tax equals total parachute payments less one times the base amount Grant Thornton LLP. All rights reserved. 31

32 Excess parachute payments Excluded from the definition of compensation: Contributions to and distributions from a qualified retirement plan, section 403(b) plan or a section 457(b) plan Compensation paid to a licensed medical professional to the extent the payment is for the performance of medical or veterinary services Compensation paid to employees who are not highly compensated (section 414(q) - $120,000 in 2018, as indexed for inflation) Parachute payments include the present value of the payments at the time of separation from employment Grant Thornton LLP. All rights reserved. 32

33 Excise tax issues Excess parachute payments do not count towards the $1M limit The same compensation cannot be subject to the 21% excise tax twice No transition relief for compensation plans already in existence Applies to taxable years beginning after December 31, 2017 Grant Thornton LLP. All rights reserved. 33

34 Open issues How is the excise tax allocated among "related persons"? Who is a related person? How is compensation allocated when a medical professional provides direct medical services and non-medical services (e.g., teaching and administration) When determining parachute payments, what is considered If a tax-exempt organization owns a taxable entity, is compensation paid to an employee of both entities subject to the excise tax? Grant Thornton LLP. All rights reserved. 34

35 Planning ahead Structure compensation arrangements to be under the $1M limit Minimize large fluctuations in compensation from year to year Should compensation arrangements include a "hair cut" to ensure the excise tax on excess parachute payments is not triggered? Consider changes to deferred compensation arrangements to avoid large amounts vesting in a single year Grant Thornton LLP. All rights reserved. 35

36 Agenda 1 Executive compensation 2 Fringe benefits 3 Retirement plans 4 Income tax withholding 5 Tax credit and individual mandate Grant Thornton LLP. All rights reserved. 36

37 Qualified moving expense reimbursement now taxable Cash reimbursement to the employee Included in income Expenses paid directly by the employer Services provided by the employer Grant Thornton LLP. All rights reserved. 37

38 Qualified moving expense reimbursement TCJA suspends section 132(a)(6) Repeals exclusion from income for qualified moving expense reimbursement How will employers react? Applies to taxable years Recognize income equal to the value of the benefit May be more costly to hire or transfer employees [Icon here] Gross-up employees for the tax? [Icon here] Employees come out of pocket for the tax? Grant Thornton LLP. All rights reserved. 38

39 Qualified bicycle commuting reimbursement Prior law: Exclude from an employee's income up to $20 per month of qualified bicycle commuting expense reimbursement by the employer TCJA suspends section 132(f)(1)(D) Any bicycle commuting reimbursement made by an employer is included in the employee's income Applies to taxable years Grant Thornton LLP. All rights reserved. 39

40 Employee achievement awards No substantial changes to law just a clarification Excludible from income: Awards of tangible personal property in recognition of length of service or safety achievement as part of a meaningful presentation. Cannot be disguised compensation Excludible from income to the extent deductible by the employer Generally up to $1,600 per employee is deductible by the employer Must not discriminate in favor of highly compensated employees The change under TCJA is not meant to be understood as a change from existing law Grant Thornton LLP. All rights reserved. 40

41 Employee achievement awards TCJA defines what is not tangible personal property Effective for amounts paid or incurred after December 31, 2017 Employee is not allowed to exclude the value from income unless the award is tangible personal property Tangible personal property does not include: Cash Cash equivalents Gift certificates (other than right to select and receive tangible personal property) Tickets to theater and sporting events Bonds Other securities Gift card and coupons Lodging Other similar items Vacations Meals Stock Grant Thornton LLP. All rights reserved. 41

42 Qualified transportation fringe No changes for employees Reimbursements or benefits still excludible from employee's income: Transportation to and from work in a commuter highway vehicle Mass transit passes Qualified parking Maximum monthly benefit (as indexed for inflation in 2018) Parking: $260 Combined transit and commuter highway vehicle: $260 Grant Thornton LLP. All rights reserved. 42

43 Qualified transportation fringe TCJA eliminates the employer's deduction Effective for taxable years beginning after December 31, 2017: Cannot deduct benefits provided or reimbursements made to employees as qualified transportation fringe benefits Exceptions: Bicycle commuting reimbursements included in the employee's income No authority to support including in an employee's income a benefit provided under a qualified transportation plan in order for the employee to receive a deduction To receive a deduction, the benefit must be provided outside a qualified plan E.g., pay cash regardless of whether it is under for qualified transportation Grant Thornton LLP. All rights reserved. 43

44 Employer-provided meals TCJA limits employer deduction Prior law: Full deduction allowed for: Meals provided at employer-operated eating facility on or near the employer's business premises and a revenue requirement met Meals provided for the convenience of the employer on the employer's business premises TCJA changes effective in 2018: Deduction for these meals is limited to 50% of the expense TCJA changes effective in 2026: No deduction is allowed for these meals Grant Thornton LLP. All rights reserved. 44

45 Tax-exempts: increase in UBI Certain otherwise non-deductible fringe benefits increase a taxexempt employer's unrelated business income for amounts paid or incurred after December 31, 2017 Certain fringes not deductible Qualified transportation Parking facility in connection with qualified parking On-premises athletic facility Increases UBI Grant Thornton LLP. All rights reserved. 45

46 Agenda 1 Executive compensation 2 Fringe benefits 3 Retirement plans 4 Income tax withholding 5 Tax credit and individual mandate Grant Thornton LLP. All rights reserved. 46

47 Repeal Roth IRA re-characterizations Roth IRA conversions (prior and current law) Permitted to convert an amount from a traditional IRA to a Roth IRA Income recognized to the extent original contributions to the traditional IRA were deducted and any earnings Prior law: Prior to the due date of the individual's tax return (including extensions), the conversion could be "recharacterized" back to a traditional IRA Unwind the Roth IRA conversion TCJA tax years beginning after December 31, 2017: No longer permitted to recharacterize the Roth IRA conversion Grant Thornton LLP. All rights reserved. 47

48 Repeal Roth IRA re-characterizations Stuck with the Roth conversion even if the value of the Roth assets decline after the conversion January 1, 2018 December 31, 2018 October 15, 2019 Convert traditional to Roth June 1, 2018 Value of the Roth assets decline X Recharacterize the Roth to a traditional Grant Thornton LLP. All rights reserved. 48

49 Extended plan loan rollover period Applies to qualified retirement plans that allow plan loans Prior law: Many plans treat unpaid participant loans as a distribution from the plan upon a participant's termination of employment or upon termination of the plan Triggers a taxable distribution To avoid a taxable distribution, plan loans were required to be repaid, or a plan offset contribution was required to be made to an eligible retirement plan, within 60 days of: Termination of employment Termination of the qualified retirement plan Grant Thornton LLP. All rights reserved. 49

50 Extended plan loan rollover period Applies to qualified retirement plans that allow plan loans TCJA effective for plan loan offset amounts treated as distributed in tax years beginning after December 31, 2017 Deadline for repayment or making the loan offset contribution is the due date for filing the federal income tax return for the year in which the applicable termination occurs Grant Thornton LLP. All rights reserved. 50

51 Agenda 1 Executive compensation 2 Fringe benefits 3 Retirement plans 4 Income tax withholding 5 Tax credit and individual mandate Grant Thornton LLP. All rights reserved. 51

52 Changes to income tax withholding TCJA made significant changes to the income tax paid by employees, including: Tax rates decreased Standard deduction increased Personal exemptions eliminated Result: significant changes to the federal income tax withholding tables Grant Thornton LLP. All rights reserved. 52

53 Changes to income tax withholding IRS statement December 26, 2017 Anticipate issuing new withholding tables in January, 2018 Employers encouraged to implement tables in February, 2018 New Forms W-4 not needed from employees Use existing 2017 withholding tables until the 2018 tables are released What to look for Income tax withholding amounts likely to decrease Unclear how exemptions claimed on existing Form W-4 will be taken into account How much time will employers receive to implement the new tables? Grant Thornton LLP. All rights reserved. 53

54 Changes to supplemental wage income tax withholding Employee's aggregate annual supplemental wages up to $1M Option: Withhold based on tables or at a flat rate Flat rate: Prior law: 25% TCJA beginning in 2018: 28% (22% may have been the intent) Employee's aggregate annual supplemental wages over $1M Flat rate withholding at highest marginal rate: 37% Implement beginning January 1, 2018 do not wait on withholding tables Grant Thornton LLP. All rights reserved. 54

55 Agenda 1 Executive compensation 2 Fringe benefits 3 Retirement plans 4 Income tax withholding 5 Tax credit and individual mandate Grant Thornton LLP. All rights reserved. 55

56 Affordable Care Act Individual shared responsibility payment (individual mandate) Pre-TCJA: In general, an individual must be enrolled in minimum essential coverage or pay an excise tax Beginning in 2019, the excise tax is reduced to $0, effectively repealing the individual mandate Impact on employers: None currently Watch out for plan costs beginning in 2019 Healthy employees may opt out of coverage Opt in when sick Grant Thornton LLP. All rights reserved. 56

57 New employer credit Employer-paid family and medical leave Tax credit for wages paid in 2018 and % of wages paid to qualifying employees during the period the employees are on family and medical leave (as defined under the Family and Medical Leave Act) Rate of pay while on leave must be at least 50% of the employee's normal wages Credit increases by.25% for each percentage point by which the rate of pay exceeds 50% - maximum credit is 25% of wages Maximum period of leave eligible for the credit: 12 weeks Grant Thornton LLP. All rights reserved. 57

58 New employer credit Employer-paid family and medical leave Tax credit requirements: Written policy All qualifying full-time employees (30 hours or more per week) at all related employers must be allowed not less than two weeks of annual paid family and medical leave Less than full-time employees must be allowed a prorated amount of paid leave Leave paid by a state or local government or required by state or local law does not count toward meeting the requirements Grant Thornton LLP. All rights reserved. 58

59 New employer credit Employer-paid family and medical leave Qualified employee: Any employee who has been employed for one year or more, and for the preceding year had compensation not in excess of 60% of the section 414(q) threshold for highly compensated employees Section 414(q) in 2017: $120,000, as indexed for inflation Eligible employee in 2018: $72,000 or less of compensation $120,000 X 60% May provide paid leave to employees who do not qualify, but it does not count towards the credit Grant Thornton LLP. All rights reserved. 59

60 Speakers Eddie Adkins Partner, Human Capital Services, Washington National Tax Office Jeff Martin Partner, Human Capital Services, Washington National Tax Office Mark Ritter Partner, Human Capital Services Grant Thornton LLP. All rights reserved. 60

61 Questions? Grant Thornton LLP. All rights reserved. 61

62 Disclaimer This Grant Thornton LLP presentation is not a comprehensive analysis of the subject matters covered and may include proposed guidance that is subject to change before it is issued in final form. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this presentation. The views and interpretations expressed in the presentation are those of the presenters and the presentation is not intended to provide accounting or other advice or guidance with respect to the matters covered For additional information on matters covered in this presentation, contact your Grant Thornton LLP adviser

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