The Tax Bill: Year-End Planning Considerations for Executive Compensation

December 21, 2017

On December 19th and 20th, 2017, the Senate and the House passed the “Tax Cuts and Jobs Act”.  President Trump will sign the Act into law, though that may not be until early January due to technical Congressional budgetary rules.

Among other things, the Act cuts the maximum corporate tax rate to 21% (from 35%), modestly reduces individual tax rates on a temporary basis through 2025, and largely eliminates the individual deduction for state and local income and property taxes during the same period.

In order to enact legislation that did not require bipartisan support in the Senate, the projected budget deficit resulting from the various tax cuts, particularly the substantial reduction in the maximum corporate rate, could not exceed $1.5 trillion over the next 10 years.  In order to accomplish this goal, since the estimated revenue loss from the tax reductions is projected to exceed $2 trillion, a sizable number of revenue raisers were included in the Act.  One of these is a substantial expansion in the scope of nondeductibility for executive compensation under section 162(m) of the Internal Revenue Code (“Section 162(m)”).

The Act amends Section 162(m) to, among other things, place a $1 million deduction cap on compensation paid to any of a public company’s named executive officers (determined under SEC proxy rules, and now including the chief financial officer) and eliminate the current exception from the $1 million deductibility limit for “performance-based compensation”.  The Act includes fairly vague “grandfathering” rules under Section 162(m) intended to cover currently excluded compensation (especially “performance-based compensation”) payable under arrangements in place before the Act was introduced in the House on November 2 that we expect will be the subject of future IRS guidance.

The Act’s changes raise a number of planning considerations for corporations with respect to employee compensation.  For example, even with the higher marginal individual tax rates in effect for 2017, some employees may want to accelerate income into 2017 so that they can fully deduct the corresponding state and local income taxes that are withheld from this income.  In addition, companies may want to accelerate tax deductions into their fiscal year beginning in 2017 since those deductions are worth up to 35% instead of 21% starting in fiscal years beginning in 2018.

Some key items that accrual-basis companies with calendar tax years may want to consider implementing before year-end include:

  • Accelerating the payment of bonuses and other compensation into 2017.  This generally would result in corporate tax deductions for this year, as well as allow employees to deduct related state and local taxes paid before year-end.  Before any payments are accelerated, care should be taken to ensure that the applicable requirements of section 409A of the Code are not violated.  In addition, for public companies, the impact under Section 162(m) should be considered for this and the other items. Section 162(m) as in effect for 2017 has strict procedural rules that must be followed for compensation to qualify as “performance-based”, in particular certification of financial results by an independent committee of board members (usually the Compensation Committee) that may be difficult to implement prior to year-end.
  • Taking action to allow for the accrual of bonuses as deductions in 2017, even if not actually paid until sometime in 2018 (but no later than March 15, 2018).  IRS guidance over the years has specified how these actions can be taken so as to allow for deductibility in 2017 but without employee income inclusion until payment is actually made in 2018.
  • Possibly taking action to permit tax deductions in 2017 for restricted stock units and similar awards that will not be settled until early 2018 (but no later than March 15, 2018) through the issuance of cash or stock.  There are a number of technical concerns that require careful planning and assessment before proceeding.

This Client Alert necessarily only scratches the surface of this complex topic.  Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues.  Please contact the Gibson Dunn lawyer with whom you usually work, or the following authors:

Stephen W. Fackler – Palo Alto and New York (+1 650-849-5385 and 212-351-2392, [email protected])
Michael J. Collins – Washington, D.C. (+1 202-887-3551, [email protected])
Sean C. Feller – Los Angeles (+1 310-551-8746, [email protected])

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