On November 2, 2017, H.R.1 or the Tax Cuts and Jobs Act (the “House Bill”) was introduced in the House of Representatives. The House Bill initially proposed to make sweeping changes to executive compensation provisions in the Internal Revenue Code of 1986, as amended (the “Code”). Among other changes, as initially proposed, the House Bill proposed to:
- Repeal Sections 409A and 457A of the Code and replace such Sections with Section 409B of the Code. While the repeal of Sections 409A and 457A would have been welcome news for many companies over the last ten or fifteen years, Section 409B would effectively prohibit the deferral of all compensation past the point in time when such compensation is no longer subject to a substantial risk of forfeiture related to the performance of services. Section 409B would apply to stock options as well (which were generally excluded from Sections 409A and 457A). The only exception to this rule would be the taxation of the transfer of property pursuant to Section 83 of the Code (other than stock options). While onerous, Section 409A at least permitted the deferral of compensation if certain requirements were met. Section 457A prohibited the deferral of compensation for service providers of nonqualified entities, which were limited and did not apply to most domestic entities. However, Section 409B effectively takes the requirements of Section 457A and makes them applicable to all companies.
- Repeal the performance-based compensation exception of Section 162(m) of the Code. All compensation paid to covered employees would only be deductible up to $1,000,000 regardless of whether the compensation was structured as performance-based compensation or not. The House Bill also expands the definition of the companies subject to Section 162(m), expands the definition of covered employee and makes the designation of any person as a covered employee permanent rather than a year by year determination for years after 2017.
- Add an excise tax of 20% for compensation paid by a tax-exempt organization in excess of $1,000,000. The excise tax is payable by the tax-exempt organization.
On November 6th and 9th, the Chairman of the Ways and Means Committee proposed two amendments to the House Bill that were adopted that would (i) remove Section 409B from the House Bill and effectively preserve current Sections 409A and 457A and (ii) include a proposed Section 83(i) which would permit the deferral of taxation for up to five years for certain stock options and restricted stock units granted with respect to stock in certain private companies to employees of such company. The removal of Section 409B was not explained, and it is not clear what lead to the change in position on nonqualified deferred compensation. The repeal of the performance-based compensation exception and the 20% excise tax for compensation paid by a tax-exempt organization in excess of $1,000,000 both remain in the House Bill as amended.
To make matters even more confusing, the Senate Finance Committee then released a proposal on tax reform later on November 9th after the amendments to the House Bill described above (the “Senate Bill”). The Senate Bill contains provisions for executive compensation that generally take the same positions as the House Bill described above prior to the amendments to the House Bill. So, the House Bill and the Senate Bill currently take different positions on nonqualified deferred compensation, and it is not clear which position will prevail (even assuming tax reform prevails in general). On November 12, 2017, Senator Portman specifically proposed amending the Senate Bill that would reject the approach of Section 409B and retain Sections 409A and 457A and the current rules on nonqualified deferred compensation, but it is not clear if such amendment will be approved.
Although there is too much uncertainty at this point to advise clients to take concrete steps based on the House Bill or the Senate Bill, it must be noted that the proposed effective date of many of the changes to executive compensation would require companies to immediately make changes to any incentive, equity or deferred compensation plans and arrangements maintained by such companies almost immediately in 2018. Companies may want to at least consider compiling a list of plans and arrangements that would be impacted by the proposed Section 409B and the proposed repeal of the performance-based compensation exception of Section 162(m) in order to be prepared to consider changes and to respond to any inquiries by directors and executives regarding the potential impact of tax reform on any compensation plans maintained by such company.
The House Bill can be found at https://waysandmeansforms.house.gov/uploadedfiles/bill_text.pdf.
The first amendment to the House Bill can be found at https://waysandmeans.house.gov/chairman-brady-introduces-amendment-tax-cuts-jobs-act/.
The second amendment to the House Bill can be found at https://waysandmeans.house.gov/chairman-brady-offers-second-amendment-tax-cuts-jobs-act/.
The Senate Bill can be found at https://www.finance.senate.gov/imo/media/doc/11.9.17%20Chairman’s%20Mark.pdf.
The amendment proposed by Senator Portman can be found on page 109 at https://www.finance.senate.gov/imo/media/doc/Master%20Tax%20Amendments.pdf.