The U.S. House and Senate have approved separate tax reform bills, each of which has similar provisions that will impact executive compensation programs. A conference committee will reconcile the differences between the two bills, so it is possible these provisions may be changed, or others that have been discarded (e.g., nonqualified deferred compensation (NQDC) repeal) could reappear. Here’s a brief summary of the key executive compensation provisions:
Changes to 162(m) and the performance-based compensation exception
Both the Senate and House versions of the tax reform bill remove the performance-based compensation exception to the $1 million pay cap under current Code section 162(m) and expand the definition of a “covered employee.” Currently the rule covers the year-end CEO and three highest paid executive officers for the year (other than the CEO). The proposals would also cover the CFO and include anyone who holds the CEO or CFO position at any time during the tax year (i.e., not just the individuals holding those positions at year-end). Each proposal also provides that an employee in that group during any year (starting with the 2017 tax year) would continue to be a covered employee as to any compensation paid by the company in future years, including after retirement, to the individual or any beneficiaries. Thus, $1 million would become a hard cap on deductible compensation, and it would apply to a larger group of employees. Both bills also expand the companies subject to the cap.
Under both bills, these changes would be applicable to taxable years beginning after December 31, 2017. However, as discussed in our recent blog post entitled “Did the Senate tax reform bill “fix” the 162(m) performance-based compensation transition rule?”, Executive Pay Matters, November 28, 2017, the Senate bill includes a transition rule that would allow companies to deduct compensation paid under a written binding contract in effect on November 2, 2017, if the terms of the contract are not modified in any material way after that date. There is no transition rule included in the House bill, so we are hopeful that the transition rule remains and that it is clarified.
Nonqualified deferred compensation (NQDC) rule repeal (removed from both bills)
The original House bill proposed to repeal Code section 409A and introduce new Code section 409B that would tax employee compensation (and earnings) as soon as no substantial risk of forfeiture exists for that compensation (i.e., receipt of the compensation is not subject to future performance of substantial services). The final version of the House bill removed that provision, and it was not made part of the final Senate bill. This will mean, unless there is a further amendment, the current rules under Code sections 409A and 83(b) will continue to apply for NQDC arrangements.
Changes to compensation programs for tax-exempt organizations
Under both bills, tax-exempt organizations would be subject to a 20% excise tax on any compensation in excess of $1 million paid to covered employees. Additionally, tax-exempt organizations would be subject to a “golden parachute” regime, imposing a 20% excise tax that is triggered when amounts in excess of three times a covered employee’s base amount is paid upon separation from service. Both bills define a covered employee to include any current or former employee who is one of the five highest compensated employees during the current tax year or for any preceding taxable year beginning after 2016. Compensation is defined broadly, to include all wages paid to the executive during the year. These provisions would apply to taxable years beginning after December 31, 2017, under both the House and Senate legislation.
Provisions in the House bill that would have eliminated deferred compensation for tax-exempt employees under Code section 457 and would have prevented tax-exempt employers from sponsoring 457(b) plans were stricken, and were not made part of the Senate bill. Additionally, the final Senate bill dropped provisions that would have changed the existing regime for determining when and if an excess benefit transaction excise tax applied, and eliminated protections provided to organization managers for reliance on professional advice.
Steve Seelig, Puneet Arora and William Kalten are regulatory advisors specializing in executive compensation in Willis Towers Watson’s Research and Innovation Center. Email firstname.lastname@example.org, email@example.com, firstname.lastname@example.org or email@example.com.