The amended version of H.R. 1, the “Tax Cuts and Jobs Act,” approved by the House Ways and Means Committee on November 9, has some key differences from the tax reform bill released by the Senate Finance Committee later that same day. While the House decided to remove the proposed changes to the nonqualified deferred compensation (NQDC) rules and leave in place the repeal of the 162(m) performance-based compensation exception, the Senate version kept intact the NQDC proposed changes and expanded the changes to 162(m). To meet Congress’s aggressive timetable for tax reform passage, if there are differences in the bills, it is speculated that the House would then move to adopt the Senate version of the bill, in its entirety, rather than have a conference committee to resolve those differences. Thus, all eyes are on the Senate version to see if the executive compensation provisions are amended during the markup that will occur next week.
Ways and Means Committee version of bill
The big change in the amended version of H.R. 1 that was approved yesterday was the removal of the provision that would create a new code section 409B and repeal existing rules on NQDC. The bill left intact the provisions that would eliminate the performance-based compensation exception to 162(m), expand the definition of “covered employees,” and the provision that would impose separate excise taxes on tax –exempt entity compensation, while removing the ability to defer compensation for highly-paid employees under code section 457(b). Please see “House bill could prompt the most significant changes in pay plan design in a generation,” Executive Pay Matters, November 7, 2017, for a more detailed analysis.
More on the Senate proposal
It is important to note that the Senate proposal does not contain legislative language, but rather was released in the form of an explanation of what the legislation is intended to accomplish. So it is possible that final legislative language can make substantive changes even where the intent is to follow the proposal. Nonetheless, the Senate proposal appears to mimic the House proposal’s original approach on the compensation provisions, as we have detailed in our November 7 blog post, with the same effective dates.
Not only would the Senate proposal retain proposed changes to 162(m), with its elimination of the performance-based exception and expansion of the definition of “covered employees,” it would also expand the reach of its $1 million “hard cap” to include all domestic publicly traded corporations and all foreign companies publicly traded through American Depository Receipts. The proposed definition may include certain additional corporations that are not publicly traded, such as large private C or S corporations. We are awaiting legislative language to determine exactly how far this expansion would go, but this provision may prove troublesome to entities previously exempt from this deduction limitation.
We did not note any changes from the House bill regarding the provision imposing an excise tax on tax-exempt entities that pay compensation exceeding $1 million. However, the proposal would make sweeping changes to the rules regarding the excess benefit transactions tax, commonly referred to as “intermediate sanctions.” Excess benefit transactions can include compensation arrangements with officers and directors of the tax-exempt organization.
The proposal would expand the group subject to taxes imposed on these transactions beyond the disqualified person being taxed for receiving the excess benefit and the organization’s managers (if they knowingly participated in the excess benefit transaction), to impose an additional excise tax on the organization providing the compensation equal to 10 percent of the excess benefit. This tax would not be due if participation by the organization in the transaction is not willful and is due to reasonable cause. No tax on the organization is imposed if it: (1) establishes that the minimum standards of due diligence (described below) were met with respect to the transaction; or (2) establishes to the satisfaction of the IRS that other reasonable procedures were used to ensure that no excess benefit was provided.
The proposal would also eliminate the current law’s rebuttable presumption of reasonableness that an organization can obtain under current law to avoid the existing tax on disqualified persons possible because of advance approval by an authorized body, reliance upon data as to comparability, and adequate and concurrent documentation. Currently, when these requirements are satisfied, the IRS may overcome the presumption of reasonableness only if it develops sufficient contrary evidence to rebut the validity of the comparability data relied upon by the authorized body. Under the proposal, these actions would only serve to support an argument by the organization that it met the minimum standards of due diligence.
The proposal would eliminate the special rule that provides that an organization manager’s participation ordinarily is not “knowing” for purposes of the intermediate sanctions excise taxes if the manager relied on professional advice to help avoid the 10% of the excess benefit requirement if they knowingly participated in the transaction. Instead, reliance on professional advice would be a relevant consideration in determining whether the manager knowingly participated in an excess benefit transaction. The proposal also eliminates the special regulatory rule that insulates a manager from being found to act knowingly for purposes of the excess benefit transaction excise if that manager relied upon professional advice.
Finally, the proposal would expand the definition of disqualified persons to now include athletic coaches for eligible educational institutions, and investment advisors to donor advised funds (as to be defined in the legislative language).
Steve Seelig, Puneet Arora and Bill Kalten are regulatory advisors specializing in executive compensation in Willis Towers Watson’s Research and Innovation Center. Email email@example.com, firstname.lastname@example.org, email@example.com or firstname.lastname@example.org.