Another Step Towards Tax Reform: Senate Releases Text of Its Tax Plan

Practical Law Legal Update w-011-7161 (Approx. 6 pages)

Another Step Towards Tax Reform: Senate Releases Text of Its Tax Plan

by Practical Law Employee Benefits & Executive Compensation

Executive Compensation-Related Provisions Under the Senate Act

Code Section 162(m)

The Senate Act would make significant changes to Code Section 162(m) (26 U.S.C. § 162(m)), including:

Eliminating the popular exceptions for qualified performance-based compensation and commissions.
Broadening the definition of "covered employee" to include:
- anyone who served as the chief executive officer or the chief financial officer at any time during the taxable year; and
- anyone who was a covered employee for any preceding taxable year beginning after December 31, 2016.
Broadening the definition of publicly held corporation to include corporations that are required to file reports under Section 15(d) of the Securities Exchange Act, which includes companies that issue securities in an SEC-registered offering which are not listed on any securities exchange.
Broadening the definition of applicable employee remuneration to include amounts includible in the income of, or payable to, persons other than the covered employee, for example, a beneficiary.

Tax-Exempt Organizations

The Senate Act would impose an excise tax on employers of certain tax-exempt organizations that pay excessive executive compensation. The tax would be equal to 20% of the sum of:

Compensation paid to covered employees that exceeds $1 million in any year.
Any excess parachute payment made to a covered employee.

A covered employee is an employee who:

Is one of the five highest compensated employees of the organization for the taxable year.
Was a covered employee of the organization (or a predecessor) for any preceding taxable year beginning after December 31, 2016.

Special Election With Respect to Private Company Illiquid Stock

The Senate Act would allow certain employees ("qualified employees") of certain private companies ("eligible corporations") to make an election under new Code Section 83(i) to defer the recognition of income on illiquid company stock acquired through the exercise of stock options or settlement of restricted stock units ("qualified stock") for up to five years after vesting.

Income would be recognized at the end of the deferral period based on the stock's value on the vesting date.

Employers who transfer qualified stock to qualified employees would be required to provide notice to employees about their ability to make a Code Section 83(i) election and would be subject to penalties for any failure to do so.

Offering employees the ability to make a Code Section 83(i) election with respect to statutory stock options would not cause the plans under which the statutory stock options were granted to lose their qualified status. However, if an employee were to make a Code Section 83(i) election, the option would no longer be qualified under Code Section 422 or 423 (26 U.S.C. §§ 422 and 423), as applicable.

An arrangement under which an employee may receive qualified stock would not be treated as nonqualified deferred compensation under Section 409A solely because of the employee's election or ability to elect to defer recognition of income under Code Section 83(i).

Benefits-Related Provisions Under the Senate Act

From an employee benefits perspective, the Senate Act would:

Suspend the exclusion for qualified bicycle commuting reimbursements for tax years beginning after December 31, 2017 and before January 1, 2026 (see Practice Note, Fringe Benefits Under Code Section 132: Qualified Bicycle Commuting Reimbursements and Fringe Benefits Toolkit).
Subject to an exception for US Armed Forces members on active duty who move due to a military order and incident to a permanent change of station, suspend the exclusion for qualified moving expense reimbursements for tax years beginning after December 31, 2017 and before January 1, 2026 (26 U.S.C. § 132(a)(6), (g); see Practice Note, Fringe Benefits: Moving Expenses).
Subject to an exception for US Armed Forces members, suspend the Code Section 217 deduction for moving expenses for tax years beginning after December 31, 2017 and before January 1, 2026 (26 U.S.C. § 217).
Eliminate the deduction for entertainment, amusement, and recreation expenses, and for dues/fees related to social, athletic, or sporting clubs or organizations.
Continue to allow employers to deduct 50% of expenses for food or beverages related to conducting the employer's trade or business (26 U.S.C. § 274(a)).
Eliminate the deduction for qualified transportation fringe benefits (as defined in Code Section 132(f)), that is:
- transit passes;
- qualified parking;
- qualified bicycle commuting reimbursements; and
- commuter transportation in a highway vehicle between the employee's home and workplace (see Practice Note, Fringe Benefits Under Code Section 132: Qualified Transportation Benefits) (26 U.S.C. § 132(f)).
Disallow a deduction for expenses incurred for providing transportation, or employee payments or reimbursement in connection with travel between the employee's residence and place of employment, unless necessary to ensuring the employee's safety.
Eliminate the deduction for meals provided for the employer's convenience on or near the employer's premises, for amounts paid or incurred after December 31, 2025.
Eliminate the ability to recharacterize contributions to a traditional IRA as contributions to a Roth IRA, and vice versa.
Create a new type of plan loan offset called a "qualified plan loan offset amount" with an extended period (until the due date for the federal income tax return for the year in which the offset occurs) for rolling over the loan balance into an eligible retirement plan.
Conform contribution limits among different types of retirement plans.
Repeal special rules for elective deferrals and catch-up contributions for Section 403(b) and governmental Section 457(b) plans.
Provide special tax relief (such as an exception from the 10% early withdrawal penalty) for Mississippi River Delta flooding victims.

Unlike an earlier version, the Senate Act no longer includes provisions:

Eliminating the ability to make catch-up contributions for employees age 50 or older who received wages of $500,000 or more in the prior year.
Applying the pre-age 59 1/2 early withdrawal penalty to distributions from governmental Section 457(b) plans.

Elimination of Individual Mandate Penalty

The Senate Bill would eliminate the penalty relating to the Affordable Care Act's (ACA's) individual mandate (that is, for individuals who fail to maintain minimum essential coverage under the ACA) (26 U.S.C. § 5000A; see Practice Note, Affordable Care Act (ACA) Overview: Individual Mandate). Earlier this year, the individual mandate was repeatedly targeted to be removed under Congress's unsuccessful efforts to repeal and replace the ACA (see Article, ACA Repeal-and-Replace Bills in the House and Senate: Individual Mandate). (However, the Senate Bill would not repeal the ACA's employer mandate.)

New Employer Credit for Family and Medical Leave

The Senate Bill would establish an employer credit for a percentage of the amount of wages paid to certain employees for the time they are on family and medical leave. The percentage would be 12.5% of wages paid, increased by 0.25 percentage points for each percentage point by which the rate of pay is more than 50% (capped at 25% of wages paid). The maximum amount of family and medical leave that could be taken into account for each employee for a tax year could not exceed 12 weeks. To be eligible for the credit, an employer's leave policy would need to provide non-part-time employees at least 2 weeks of annual paid family and medical leave.

Effective Date

The Senate Act would generally apply to taxable years beginning after December 31, 2017. However, the Senate Act exempts from the Code Section 162(m) amendments compensation under a written binding contract that was in effect on November 2, 2017 and that is not subsequently materially modified.

Bill Status

The Senate is expected to vote on the legislation the week of November 27, 2017. The Senate and House versions of the tax bill need to be reconciled before a final version can be sent to the President. A legislative and lobbying fight over the bills is expected to continue over the coming weeks, with a goal of passing a single bill in both the House and the Senate before December 25, 2017. Practical Law will continue follow the bills' progress and report on significant new developments.

Another Step Towards Tax Reform: Senate Releases Text of Its Tax Plan | Practical Law