US Tax Reform: Tax Cuts and Jobs Act Expected to Come into Effect in 2018

Size: px

Start display at page:

Download "US Tax Reform: Tax Cuts and Jobs Act Expected to Come into Effect in 2018"

Anna George
6 years ago
Views:

1 Client Alert Cmpensatin December 20, 2017 US Tax Refrm: Tax Cuts and Jbs Act Expected t Cme int Effect in 2018 As f December 20, 2017, bth the Huse f Representatives and the Senate have vted t apprve the final versin f the Tax Cuts and Jbs Act, in substantially the frm released by the Cnference Cmmittee n December 15 th. The bill is expected t be presented t the President fr signature befre Christmas, making US tax refrm a reality fr What s In? Frm a Cmpensatin & Benefits perspective, amng ther things, the apprved bill includes: Significant changes t Cde Sectin 162(m); A new tax deferral regime fr ptins and RSUs granted by private cmpanies; Eliminatin f exclusin fr fewer than expected emplyer-prvided fringe benefits; and Increased disallwance f cmpensatin-related deductins under Cde Sectin 274 What s Out? Frtunately, the final bill des nt include a Senate prpsal t require the use f a first-infirst-ut (FIFO) methdlgy when calculating capital gains n sale f shares, nr des it add back any f the changes t nnqualified deferred cmpensatin that were prpsed in the initial Huse versin f the bill. Als, mst f the changes prpsed t qualified retirement plans have been eliminated. Sectin 162(m) Expanded, Effective fr Taxable Years Beginning After December 31, 2017, Subject t a Transitin Rule The final bill fllws the Senate Mark and the Huse bill. In ther wrds: The CEO, CFO, and tp three ther highest paid executive fficers in a year are treated as cvered emplyees subject t sectin 162(m) deductin disallwance n remuneratin in excess f $1,000,000 in that year and all future years, including years fllwing terminatin f emplyment, and regardless f whether the cmpensatin is payable t the executive r n the executive's behalf. There is n lnger an exceptin frm sectin 162(m) fr perfrmance-based and cmmissin cmpensatin. The sectin 162(m) deductin disallwance has been expanded t all cmpanies that file SEC reprts, including cmpanies issuing public debt r equity, nn-u.s. issuers publicly traded thrugh ADRs, and certain large private C and S crpratins. Transitin Rule: The expanded sectin 162(m) prvisins are generally applicable fr taxable years beginning after December 31, Hwever, the expanded prvisins d nt apply t remuneratin prvided pursuant t a written binding cntract in effect n Nvember 2, 2017 which is nt mdified in any material respect after that date. Based n the Jint Explanatry Statement f the Cnference Cmmittee, this is intended t be a narrwly drawn transitin rule. The fact that a plan f remuneratin was in existence n Nvember 2 is nt by itself sufficient t qualify the plan as a binding written cntract, unless (i) the executive had a written binding cntractual right t participate under the plan, e.g., pursuant t a written emplyment agreement in effect n Nvember 2, (ii) amunts payable under the plan are nt subject t discretin, and (iii) the crpratin des nt have the right t amend materially the plan r terminate the plan (except n a prspective basis befre v7\GESDMS 1

2 any services are perfrmed with respect t the applicable perid fr which such cmpensatin is t be paid). The exceptin ceases t apply t amunts paid after there has been a material mdificatin and des nt apply t any cntract entered int r renewed after Nvember 2, A cntract that is terminable at will by either r bth parties (ther than a cntract that can nly be terminated by terminating the emplyment relatinship) is cnsidered a new cntract (fr which the exceptin wuld nt apply) n the date any such terminatin wuld be effective. Practical Tip #1: Althugh it is likely that mst cmpanies will cntinue t pay perfrmancebased cmpensatin due t the influence f sharehlders and ther stakehlders, there is n need t include 162(m)-type prvisins (e.g., individual limits n the maximum cmpensatin payable during the taxable year, prhibitin n psitive discretin, etc.) in executive cmpensatin arrangements fr taxable years after Cnsider whether such prvisins can be deleted frm existing executive cmpensatin arrangements withut sharehlder apprval. Practical Tip #2: There is n need t seek sharehlder apprval f perfrmance-based cmpensatin arrangements, nr t have such arrangements administered by a cmmittee f independent directrs, slely t qualify as "perfrmance-based cmpensatin" fr sectin 162(m) purpses fr taxable years after Practical Tip #3: Avid amending any cmpensatin arrangement that was in effect as f Nvember 2, 2017, s as t preserve any available transitin relief. Guidance Needed: Guidance is needed t clarify that transitin rule relief is available where the emplyer r a cmmittee f independent directrs has retained the right t reduce cmpensatin payable under a binding written cntract in effect n Nvember 2, 2017 (scalled "negative discretin"). Guidance Needed: Guidance is needed t clarify that transitin rule relief is available where a binding written cntract in effect n Nvember 2, 2017 des nt expressly prvide fr its terminatin r cancellatin. Guidance Needed: Guidance is needed t clarify that awards under a written sharehlder-apprved annual cash incentive plan qualify fr the transitin rule even thugh there is n written cntract between the executive and the cmpany. New Incme Tax Deferral fr Private Cmpany Equity Awards The final bill generally fllws the Senate bill (which was generally the same as the Huse bill), with sme minr mdificatins. The bill wuld allw eligible emplyees f private cmpanies (cmpanies whse stck is nt publicly traded n an established securities market) t make an electin t defer payment f incme tax t the earliest f: 1. the stck becming transferable (including t the cmpany); 2. the stck f the cmpany becming publicly traded n an established securities market, such as upn an IPO; 3. five years after the vesting date; 4. the emplyee lsing his r her status as an eligible emplyee; and 5. the emplyee revking the deferral electin. The amunt f incme that wuld be required t be recgnized under the deferral electin wuld be based n the value f the stck at the time the emplyee s rights in such stck first became transferable r nt subject t substantial risk f frfeiture, withut regard t whether such value decreases (r increases) during the deferral perid. The electin, which will have similar prcedural requirements t a Sectin 83(b) electin, must be made n later than 30 days after the emplyee s right t the stck is substantially vested v7\GESDMS 2

3 All full-time emplyees are eligible t make an electin under the deferred tax rules, excluding an emplyee wh: 1. first becmes in any taxable year r was at any time in the 10 preceding calendar years a 1% wner f the cmpany; 2. is r has been the cmpany s CEO r CFO; 3. is related t the CEO, CFO r frmer CEO r CFO; 4. first becmes in any taxable year r was at any time in the 10 preceding calendar years ne f the cmpany s fur highest paid fficers. Amng ther requirements, t qualify fr the deferred taxatin, the equity awards must be ffered n terms that prvide the same rights and privileges (ther than with respect t the number f underlying shares) t at least 80% f emplyees prviding services in the US and the cmpany must nt have repurchased any f its utstanding stck in the preceding year, unless at least 25% f the dllar amunt f the repurchased stck was stck issued t emplyees electing t defer taxatin under the deferred tax rules. It is nt clear hw cmpanies wh have repurchased shares in 2017 will be able t satisfy this requirement in 2018 withut specific transitin relief. The bill prvides clarificatins n the applicatin f the legislatin, including the fllwing: 1. deferral electins fr stck issuable pursuant t ptins under Cde Sectin 423 ESPPs will be taxable as nnstatutry stck ptins fr FICA purpses and will be subject t incme taxatin under the deferral rules; and 2. emplyees excluded frm making a deferral electin include individuals wh first becme a 1% wner r ne f the 4 highest cmpensated fficers in a taxable year even if the individual may nt have met these requirements fr the 10 preceding taxable years. The Jint Explanatry Statement f the Cnference Cmmittee makes it clear that the determinatin f when stck first becmes transferable r is n lnger subject t a substantial risk will be limited t the circumstances described in Cde sectin 83(c)(3) and the related treasury regulatins, e.g., incme inclusin cannt be delayed due t an IPO lck-up perid. Practical Tip: Private cmpanies granting ptins r RSUs ver stck that qualifies fr the new deferral electin shuld cnsider prviding emplyees with a cmmunicatin, beynd the required ntice mandated in the prvisin, that describes the tax implicatins f making a deferral electin, including (i) incme tax cannt be deferred beynd five years fllwing the vesting date, even if there has nt been an IPO f the cmpany r ther liquidity event by that time, (ii) tax deferrals with respect t shares issuable upn the exercise f Cde sectin 422 incentive stck ptins r Cde sectin 423 ESPPs will nt be eligible fr the favrable tax treatment therwise available t such ptins, (iii) FICA will nnetheless be due upn exercise f ptins/vesting f restricted stck units (as is the case fr any deferral under the new rules). Guidance Needed: The legislatin is lacking clarity n whether the amunt includible in incme fr a deferral made in cnnectin with an ptin exercise wuld be calculated based n the ptin spread at exercise r at vesting. It wuld be mre favrable t the emplyee (and wuld be cnsistent with the current taxatin f ptins) if the amunt f the includible incme was determined based n the ptin spread at exercise, but the legislatin suggests that the includible amunt culd be based n the ptin spread at vesting. Eliminatin f Exclusin fr Certain Emplyer-Prvided Fringe Benefits While the Huse bill wuld have dne away with the exclusins fr a number f ppular emplyer-prvided fringe benefits, the final bill has left mst exclusins intact. The fllwing chart summarizes the status f these exclusins under the final bill: v7\GESDMS 3

4 Fringe Benefit Treatment in Huse and Senate Ultimate Treatment in Final Bill Sectin 74 Emplyee Achievement Awards Huse bill repealed sectin 74(c) exclusin frm Fllws the Senate Amendment incme fr emplyee achievement awards; limiting excludable emplyee Senate bill limits excludable emplyee achievement awards t certain achievement awards t certain tangible prperty. tangible prperty. Sectin 119 Huse bill cntained varius limits n ldging that culd be prvided n emplyer s premises n an excludable basis; the Senate bill had n such limitatins. limitatins n emplyerprvided ldging. Sectin 127 Educatin Assistance Huse bill repealed exclusin; Senate bill had n prvisin. Des nt include Huse repeal f sectin 127. Sectin 129 Dependent Care Assistance Huse bill repealed dependent care exclusin effective in 2023; Senate bill had n prvisin. sunset f the dependent care exclusin. Sectin 132(a)(6) Mving Expense Reimbursements Huse bill repeals exclusin fr qualified mving Fllws the Senate amendment expense reimbursements, except fr the military; pstpning the effective date f Senate bill is the same, but pstpnes the the exclusin s repeal until effective date until Sectin 132(f) Bicycle Cmmuting Benefit Sectin 137 Adptin Assistances Huse bill had n prvisin; Senate bill suspends exclusin fr Huse bill repealed the exclusin fr adptin assistance; Senate bill cntained n prvisin. Includes Senate suspensin. repeal f the adptin assistance exclusin. Instead f ding away with exclusins, the final bill fcuses mre n disallwing deductins t the emplyer, as described belw. Expanded Deductin Disallwances Under Cde Sectin 274 The final bill fllws the Senate bill in terms f expanding the deductin disallwance under Sectin 274. What this means is that the Sectin 274 deductin disallwance applies t entertainment that is directly related t the cnduct f a trade r business. Further, Sectin 274 is expanded t disallw a deductin fr qualified transprtatin expenses (e.g., mass transit and parking benefits), and ther emplyee cmmuting expenses unless needed t ensure the emplyee s safety. The bill s treatment f meal expenses is quite cmplicated. First, effective fr amunts incurred r paid after December 31, 2017, the exceptin frm the 50% deductin disallwance fr fd and beverage that are excludable frm incme under sectin 132 as de minimis fringe benefits is repealed, s that such de minimis fd and beverage expenses are subject t 50% disallwance. Secnd, fd and beverage expenses, and expenses f perating an eating facility, are fully nn-deductible under new sectin 274(), beginning with such expenses paid r incurred after December 31, Majrity f Qualified Retirement Prvisins Stripped Frm Bill Bth the Huse and Senate bill had cntemplated making a number f changes t qualified retirement plans. While certain disaster relief and lan prvisins remain in the final bill, the majrity f these prpsed changes were eliminated. Please cntact yur Cmpensatin attrney with any questins related t the tax legislatin v7\GESDMS 4

Fr mre infrmatin n the brader implicatins f the tax

McKenzie Tax Practice Grup client alerts: The Tax

First Time in Thirty Years US Tax Refrm - Prvisins

Refrm - Prvisins Impacting Private Equity Fr Mre

batter Nicle Calabr +1 415 576 3010 nicle.

diamnd Victr Flres +1 415 591 3229 victr.

glagau Christpher Guldberg +1 312 861 6630

guldberg Sinead Kelly +1 415 591 3241 sinead.

klementz Maura Ann McBreen +1 312 861 6630 mauraann.

lindsay.minnis Aimee Sdan +1 312 861 7515 aimee.

wydajewski Disclaimer - Baker & McKenzie

5 Fr mre infrmatin n the brader implicatins f the tax legislatin n yur cmpany, please see tday's Baker McKenzie Tax Practice Grup client alerts: The Tax Cuts and Jbs Act: Cngress Passes a Majr Tax Bill fr First Time in Thirty Years US Tax Refrm - Prvisins Impacting the Renewable Energy Industry US Tax Refrm - Prvisins Impacting Private Equity Fr Mre Infrmatin Narendra Acharya narendra.acharya Anne Batter Tax Washingtn, D.C anne.batter Nicle Calabr nicle.calabr Valerie Diamnd valerie.diamnd Victr Flres victr.flres Denise Glagau denise.glagau Christpher Guldberg christpher.guldberg Sinead Kelly sinead.kelly Barbara Klementz barbara.klementz Maura Ann McBreen mauraann.mcbreen Lindsay Minnis New Yrk lindsay.minnis Aimee Sdan aimee.sdan Brian Wydajewski brian.wydajewski Disclaimer - Baker & McKenzie Internatinal is a Swiss Verein with member law firms arund the wrld. In accrdance with the cmmn terminlgy used in prfessinal service rganizatins, reference t a "partner" means a persn wh is a partner, r equivalent, in such a law firm. Similarly, reference t an "ffice" means an ffice f any such law firm v7\GESDMS 5

Tax Reform Series II: Retirement Plan and IRA Provisions

Tax Reform Series II: Retirement Plan and IRA Provisions If yu have questins, please cntact yur regular Grm attrney r ne f the attrneys listed belw: Elizabeth Dld edld@grm.cm (202) 861-5406 David Levine dlevine@grm.cm (202) 861-5436 Mark Lfgren mlfgren@grm.cm