The new draft tax bill, unveiled last week by the Trump administration has many provisions which would significantly affect many businesses in the United States. This post does not focus on all of the implications for the draft tax bill for companies, but highlights two provisions, which, if enacted, will turn the world of executive compensation for both public and private companies upside down.
Repeal of 409A/Replacement with 409B (Title III, Subtitle I, Sec.3801)
Section 409A would be repealed and replaced by 409B, which effectively would end most deferred compensation. Under 409B, an employee would be taxed on non-qualified compensation as soon as there is no substantial risk of forfeiture with regard to that compensation. The only substantial risk of forfeiture would be performance of services (i.e., time-based vesting). Performance vesting and covenants not to compete would not be considered a substantial risk of forfeiture. It also would apply to equity compensation such as RSUs, PSUs, SARs and stock options as well as to severance payments. Section 409B would be effective for amounts attributable to services performed after 2017. Current law would apply to existing non-qualified deferred compensation arrangements until the last tax year beginning before 2026, when such arrangements would become subject to the new provision.
Changes to 162(m) (Title III, Subtitle I, Sec.3802)
Section 162(m) would be amended in two important ways. First, the exceptions to the $1 million deduction limitation under 162(m) for commissions and performance-based compensation would be repealed. Thus, performance based compensation and options/SARs no longer would be exempt. Second, the definition of “covered employee” would be revised to include the CEO, the CFO and the three other highest paid employees (instead of the CEO and the next four highest compensated officers). Once an individual qualifies under the definition, the deduction limitation would apply for federal tax purposes so long as the corporation pays remuneration to that person or his or her beneficiaries. These changes would be effective for tax years beginning after 2017.
While of course this is proposed legislation, and one doesn’t know where this will go or if it will be revised along the way, it is important for employers to understand the possible impact of these provisions. As was the case when 409A was first enacted, there will likely be frustration and confusion along the way. Employers should keep an eye on this draft bill, and, if the bill becomes law, it would be prudent to seek out executive compensation and employment lawyers for guidance. Stay tuned, this could get very interesting…