Does your organization offer stock options or substantial salaries to executives and other employees? It’s important that you review your compensation arrangements in light of changes made by the Tax Cuts and Jobs Act (TCJA). Although the legislation was passed in December 2017, many employers are still dealing with its impact.

Pre-TCJA

Prior to the TCJA, employers generally could deduct the compensation and wages paid to employees as “ordinary and necessary” business expenses. Section 162(m) limited publicly traded companies to a $1 million deduction for compensation paid to “covered employees” (defined as a company’s CEO and the next three highest paid executives, besides the CEO and CFO).

However, the IRS provided an exemption to the $1 million for commissions and compensation which qualified as “performance based”. Performance based compensation includes annual incentive plan payouts, stock options, appreciation rights and performance based equity awards.

What changed under the TCJA?

1. Under the TCJA, commissions and performance-based compensation are no longer exempt from the $1 million limit, hence all compensation exceeding $1 million is no longer tax deductible.

2. In addition the definition of “covered employees” has been expanded to include:

• The CFO (or principal financial officer)
• Anyone who served as the CEO or CFO at any point during the taxable year (the prior rule only considered executives who served in such roles at the end of the year)

*Under the new rules, anyone who was a covered employee for a taxable year beginning after December 31, 2016 will remain a covered employee for all future years, even if the individual ceased being an officer.

3. The scope of companies subject to 162(m) also expanded to include private companies that register debt or equity securities with the Securities and Exchange Commission, including foreign companies publicly traded through ADRs.

Grandfather rule

In 2018, the IRS issued Notice 2018-68 clarifying changes made to Section 162(m), including a grandfather, or transition rule (provision where an old rule continues to apply to some existing situations while a new rule will apply to all future cases). Payments exceeding $1 million can continue to be fully deductible under the grandfather rule. The changes to Code Section 162(m) will not apply to compensation payable pursuant to a written binding contract that was in effect November 2^nd 2017 (so long as the contracts have not been materially modified thereafter). Deductible compensation under the grandfather rule includes existing stock options and other performance-based equity awards.

What is material modification?

Typically a material modification occurs when a contract is amended to increase the compensation amount payable to an employee.

Other compensation considerations from the TCJA

Check out our blog, Tech Companies, Let’s Review Your Compensation Plan under New Tax Law. There are some other limitations under the TCJA regarding…

• Meals and entertainment- Do you provide meals for your employees? If so, amounts paid or incurred in 2018 and beyond may be only 50% deductible if they fall under these categories- de minimis meals, meals provided for the employer’s convenience, or meals at employer-operated eating facilities.
• Transportation fringes- Employers can no longer deduct the cost of qualified employee transportation fringe benefits (for example, parking allowances, mass transit passes and van pooling).
• Relocation packages- Employers can no longer deduct pay or reimburse an employee’s moving expenses on a tax-free basis. Starting in 2018, reimbursed employee moving expenses are includable in W-2 wages and deductible as a compensation expense.

Going forward you’ll want to review your existing incentive plans to determine whether any changes should be made to compensation arrangements.

Need help navigating the TCJA? Contact us.

The TCJA…So Many Changes, So Many Questions…we can help you navigate this huge tax overhaul! Visit our Tax Reform Center for everything you and your business need to know, now.