Employee Benefit Issues After Tax Reform May 7 th, 2018 TEI Houston Tax School 2018
2 Presenter Jeff Martin Partner, Grant Thornton LLP Washington National Tax Office Jeffrey.Martin@us.gt.com (202) 521-1526
Agenda Tax credits Expansion of section 162(m) Fringe benefits Other items
Tax Reform Effectiveness, Current Status and Pending Guidance Tax Cuts and Jobs Act (TCJA) signed into law December 22, 2017 Generally effective as of January 1, 2018 or for tax years beginning after December 31, 2017 Guidance / Interpretation of new law? Joint Explanatory Statement of the Conference Committee Blue Book by Joint Committee on Taxation Treasury and IRS guidance and regulations Technical corrections bill may be necessary (though hard to pass)
Tax credits
Employer-paid family and medical leave credit Tax credit for wages paid in 2018 and 2019 12.5% 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
FML 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
FLM Credit: 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
FLM Credit: Types of leave Credit is available for amounts paid during any of the following types of leave: Maternity or paternity leave for the birth of a child Leave for the placement of a child with the employee for adoption or foster care Leave while the employee provides care for the employee's spouse, son, daughter, or parent who has a serious health condition Leave while the employee has a serious health condition and is unable to work Qualifying leave arising out of the fact that the spouse, son, daughter or parent of the employee is on covered active duty in the Armed Forces Qualifying leave to care for an employee's spouse, son, daughter, parent or next of kin who is a service member Employer is not required to provide all types of paid leave
Employee retention credit Hurricane Harvey Available to businesses operating inside a federally declared disaster zone for Hurricane Harvey Also available for Hurricanes Irma and Maria Credit = up to 40% of wages paid to eligible employees (max $6,000 per employee) beginning on the date the employer's place of business became inoperable due to Hurricane Harvey and ending on the earlier of: The date the business resumes significant operations January 1, 2018 General business tax credit
Section 162(m)
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
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. 13
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. 14
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 on 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 termination or death)
1 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
1 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
1 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. 1.162-27(h) Transition relief when section 162(m) was enacted
1 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?
2 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)
2 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
2 Section 162(m) Tax accounting Consider whether adjustments are required to current deferred tax assets Position regarding transition relief likely taken at year-end Apply the same position until IRS guidance is available "Cash first" or "equity first" approach for recording DTAs and impact of section 162(m) Accounting policy How do you address the section 162(m) impact on the stock option DTA for 2018 awards?
Fringe benefits
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. 24
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 2018 2025 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. 25
Transit and Commuting The legislation s focus in this area is on deduction disallowances, rather than on making the benefit taxable to the employees Two separate changes made: 1. Section 274(a)(4) impacts deduction for expenses of qualified transportation fringes 2. Section 274(l) separately impacts the deduction for commuter benefits Effective for taxable years beginning after December 31, 2017
Transit and Commuting Section 274(a)(4) disallows the employer s deduction for the costs of qualified transportation fringes: Commuter shuttles/vans Transit passes Qualified parking Qualified bicycle reimbursement IRS: Applies to employee elective contributions
Transit and Commuting Section 274(l) disallows the employer s deduction for the costs of providing transportation between an employee s place of residence and work, except as necessary for ensuring the safety of the employee Significant overlap with commuter shuttles/vans and transit benefits disallowed in section 274(a)(4) This can be a double hammer where commuting benefit is taxable The reach of the exception for the safety of the employee is not clear
Meals Provided to Employees De minimis meals that are no longer exempt from 50 percent deduction disallowance due to repeal of Section 274(n)(3): Coffee and doughnuts Group meals Subsidized company cafeterias Section 119 meals This provision is effective for amounts paid or incurred after December 31, 2017
Meals Provided to Employees New section 274(o) disallows: the expenses for operation of a facility described in section 132(e)(2) (a subsidized employer cafeteria), including the food or beverage expenses any expense for section 119(a) meals This provision is effective for amounts paid or incurred after December 31, 2025
Other
Retirement plans Repeal of Roth recharacterization Extended plan loan rollover period Remove six-month prohibition on elective deferrals following a hardship distribution (Budget Act) Hardship distributions may include earnings and employer contributions (Budget Act) IRA and qualified plan distributions by reason of an IRS levy returned to the individual may be recontributed to the IRA or plan, and taxes paid on the distribution are refunded (Budget Act)
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 2018-2025
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
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 card and coupons Gift certificates (other than right to select and receive tangible personal property) Tickets to theater and sporting events Lodging Vacations Meals Stock Bonds Other securities Other similar items
3 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 full-time 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 Lore m [Icon here] Restricted stock units
3 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)
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
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 privileges 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
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
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
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
Repeal Roth IRA recharacterizations Roth IRA conversions (prior and current law) Permitted to convert an amount from a traditional IRA to a Roth IRA Prior law: Income recognized to the extent original contributions to the traditional IRA were deducted and any earnings 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
Repeal Roth IRA recharacterizations 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
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