Proposed Tax Bill Radically Alters Nonqualified Deferred Compensation and Executive Compensation
November 8, 2017
Nonqualified deferred compensation has long been used by employers as a cost-effective and flexible tool to attract, engage, and retain top talent within an organization. This may all change in the not so distant future. On November 2, 2017, the House Ways and Means Committee released proposed tax legislation — H.R. 1 — Tax Cuts and Jobs Act (the “Bill”). If enacted as written, the Bill would effectively kill nonqualified deferred compensation and eliminate the benefits of stock options and other appreciation rights.
Under the Bill, the complicated rules of Internal Revenue Code (“Code”) Section 409A would be repealed and replaced with a new Code Section 409B. Code Section 409B would apply to compensation attributable to services performed after December 31, 2017, which means there is limited time to prepare. The proposed changes to nonqualified deferred compensation are highlighted below.
• New Code Section 409B would effectively eliminate deferrals of base, bonus, and other forms of nonqualified deferred compensation including stock options, stock appreciation rights, and restricted stock units.
• All nonqualified deferred compensation would be taxed at vesting, regardless of whether exercised or paid, once there is no longer a substantial risk of forfeiture.
• Only service-based vesting would be treated as being subject to a substantial risk of forfeiture.
• Performance-based vesting would be ignored.
• Limited grandfathering would be available to amounts attributable to services performed before January 1, 2018, but such amounts would need to be taxed and distributed before 2026.
The proposed changes would generally tax nonqualified deferred compensation under the same approach used for tax-exempt organizations, Code Section 457(f), offering little opportunity to defer compensation beyond employment. The Bill, if passed in its current form, would apply to amounts attributable to services performed after 2017, and it is anticipated to increase revenues by $16.2 billion over 2018-2027.
The Bill also makes significant changes to other executive compensation items including:
• Amending Code Section 162(m) to eliminate the exemption for performance-based compensation;
• Imposing a new 20 percent excise tax on tax-exempt organizations with covered employees making more than $1 million; and
• Eliminating deferrals of compensation under Code Section 457(b) for employees of tax-exempt organizations.
Although the Bill is still in a proposed state and subject to modification, it is a strong indication of the road ahead. Employers should review and inventory all deferred compensation arrangements, including equity awards, now and prepare to advise Compensation Committees of potential implications.
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