On December 22, President Trump signed into law H.R. 1, the “Tax Cuts and Jobs Act,” a sweeping tax reform law that promises to entirely change the tax landscape.
While the final version of the legislation carries the title “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” this article refers to the Act by its former and commonly used name: The “Tax Cuts and Job Act.”
This article describes the Act’s pension and benefit changes, including those regarding:
- repeal of the rule allowing recharacterization of IRA contributions,
- extended rollover period for rollover of plan loan offset amounts,
- relief from early withdrawal tax for “qualified 2016 disaster distributions,”
- length of service award programs for public safety volunteers,
- deferred compensation—new deferral election for qualified equity grants,
- limitation on excessive employee compensation,
- stock compensation of insiders in expatriated corporations,
- excise tax on excess tax-exempt organization executive compensation,
- repeal of the Affordable Care Act (ACA, or Obamacare) individual mandate,
- qualified bicycle commuting exclusion suspended,
- limitation of employer’s deduction for fringe benefit expenses,
- employee achievement awards, and
- new credit for employer-paid family and medical leave.
RIA observation: One of the major distinctions between the House and Senate versions of the tax bill was that the Senate bill, in order to comply with certain budgetary constraints, contained a “sunset,” or an expiration date, for many of its provisions—e.g., the provisions apply for tax years beginning before January 1, 2026. Thus, many of the individual tax provisions in the Act are temporary (as opposed to the business provisions, which generally are permanent). Meeting these budget constraints is key as doing so allows the Senate to pass the bill under reconciliation procedures, meaning that only a bare majority vote is required, instead of the 60-vote threshold that typically applies, which in this case means without bipartisan support. As the Senate continues to be subject to these budgetary constraints, these “sunsets” generally made it into the Conference Committee’s reconciled version of the bill.
Repeal of the Rule Allowing Recharacterization of IRA Contributions
Under pre-Act law, if an individual makes a contribution to an IRA (traditional or Roth) for a tax year, the individual is allowed to recharacterize the contribution as a contribution to the other type of IRA (traditional or Roth) by making a trustee-to-trustee transfer to the other type of IRA before the due date for the individual’s income tax return for that year. In the case of a recharacterization, the contribution will be treated as having been made to the transferee IRA (and not the original, transferor IRA) as of the date of the original contribution. Both regular contributions and conversion contributions to a Roth IRA can be recharacterized as having been made to a traditional IRA.
New law. For tax years beginning after December 31, 2017, the rule that allows a contribution to one type of IRA to be recharacterized as a contribution to the other type of IRA does not apply to a conversion contribution to a Roth IRA. Thus, recharacterization cannot be used to unwind a Roth conversion. (Code Sec. 408A(d), as amended by Act Sec. 13611)
Extended Rollover Period for Rollover of Plan Loan Offset Amounts
If an employee stops making payments on a retirement plan loan before the loan is repaid, a deemed distribution of the outstanding loan balance generally occurs. Such a distribution is generally taxed as though an actual distribution occurred, including being subject to a 10% early distribution tax, if applicable. A deemed distribution isn’t eligible for rollover to another eligible retirement plan.
Under pre-Act law, a plan may also provide that, in certain circumstances (for example, if an employee terminates employment), an employee’s obligation to repay a loan is accelerated and, if the loan is not repaid, the loan is cancelled and the amount in the employee’s account balance is offset by the amount of the unpaid loan balance, referred to as a “loan offset.” A loan offset is treated as an actual distribution from the plan equal to the unpaid loan balance (rather than a deemed distribution), and (unlike a deemed distribution) the amount of the distribution is eligible for tax-free rollover to another eligible retirement plan within 60 days. However, the plan is not required to offer a direct rollover with respect to a plan loan offset amount that is an eligible rollover distribution, and the plan loan offset amount is generally not subject to 20% income tax withholding.
New law. For plan loan offset amounts which are treated as distributed in tax years beginning after December 31, 2017, the Act provides that the period during which a “qualified plan loan offset” amount may be contributed to an eligible retirement plan as a rollover contribution would be extended from 60 days after the date of the offset, to the due date (including extensions) for filing the federal income tax return for the tax year in which the plan loan offset occurs—that is, the tax year in which the amount is treated as distributed from the plan. A “qualified plan loan offset amount” is a ”plan loan offset amount” that is treated as distributed from a qualified retirement plan, a Code Sec. 403(b) plan, or a governmental Code Sec. 457(b) plan solely by reason of the termination of the plan, or the failure to meet the repayment terms of the loan because of the employee’s separation from service, whether due to layoff, cessation of business, termination of employment, or otherwise. A “plan loan offset amount” under the Act (as before) is the amount by which an employee’s account balance under the plan is reduced to repay a loan from the plan. (Code Sec. 402(c), as amended by Act Sec. 13613)
Relief from Early Withdrawal Tax for “Qualified 2016 Disaster Distributions”
A distribution from a qualified retirement plan, a tax-sheltered annuity plan, an eligible deferred compensation plan of a state or local government employer, or an IRA generally is included in income for the year distributed. In addition, unless an exception applies, distribution from a qualified retirement plan, a Code Sec. 403(b) plan, or an IRA received before age 59½ is subject to a 10% additional tax under Code Sec. 72(t) (the “early withdrawal tax”) on the amount includible in income.
In general, a distribution from an eligible retirement plan may be rolled over to another eligible retirement plan within 60 days, in which case the amount rolled over generally is not includible in income. The 60-day requirement can be waived by IRS in certain situations.
New law. The Act provides an exception to the retirement plan 10% early withdrawal tax for up to $100,000 of “qualified 2016 disaster distributions.” (Act Sec. 11028(b)) These distributions are defined as distributions from an “eligible retirement plan” made (a) on or after January 1, 2016, and before January 1, 2018, to an individual whose principal place of abode at any time during calendar year 2016 was located in a 2016 disaster area, and who has sustained an economic loss by reason of the events that gave rise to the Presidential disaster declaration. An “eligible retirement plan” means a qualified retirement plan, a Code Sec. 403(b) plan, or an IRA.
Income attributable to a qualified 2016 disaster distribution can, under the Act, be included in income ratably over three years (Act Sec. 11028(b)(1)(E)), and the amount of a qualified 2016 disaster distribution can be recontributed to an eligible retirement plan within three years.
The Act also provides that a plan amendment made pursuant to the above disaster relief provisions may be retroactively effective if certain requirements are met, including that it be made on or before the last day of the first plan year beginning after December 31, 2018 (December 31, 2020 for a governmental plan), or a later date prescribed by IRS. (Act Sec. 11028(b)(1)(F)(2)(B))
Length of Service Award Programs for Public Safety Volunteers
Under pre-Act law, any plan that solely provides length of service awards to bona fide volunteers or their beneficiaries, on account of qualified services performed by the volunteers, is not treated as a plan of deferred compensation for purposes of the Code Sec. 457 rules. Qualified services are fire fighting and prevention services, emergency medical services, and ambulance services, including services performed by dispatchers, mechanics, ambulance drivers, and certified instructors. The exception applies only if the aggregate amount of length of service awards accruing for a bona fide volunteer with respect to any year of service does not exceed $3,000.
New law. For tax years beginning after December 31, 2017, the Act increases the aggregate amount of length of service awards that may accrue for a bona fide volunteer with respect to any year of service, from $3,000 to $6,000, and adjusts that amount to reflect changes in cost-of-living. Also, if the plan is a defined benefit plan, the limit applies to the actuarial present value of the aggregate amount of length of service awards accruing with respect to any year of service. Actuarial present value is calculated using reasonable actuarial assumptions and methods, assuming payment will be made under the most valuable form of payment under the plan, with payment commencing at the later of the earliest age at which unreduced benefits are payable under the plan, or the participant’s age at the time of the calculation. (Code Sec. 457(e), as amended by Act Sec. 13612)
Deferred Compensation—New Deferral Election for Qualified Equity Grants
Code Sec. 83 governs the amount and timing of income inclusion for property, including employer stock, transferred to an employee in connection with the performance of services. Under Code Sec. 83(a), an employee must generally recognize income for the tax year in which the employee’s right to the stock is transferable, or isn’t subject to a substantial risk of forfeiture. The amount includible in income is the excess of the stock’s fair market value at the time of substantial vesting, over the amount, if any, paid by the employee for the stock.
New Law. Generally effective with respect to stock attributable to options exercised, or restricted stock units (RSUs) settled, after December 31, 2017 (subject to a transition rule; see below), a qualified employee can elect to defer, for income tax purposes, recognition of the amount of income attributable to qualified stock transferred to the employee by the employer. (Code Sec. 83(i), as amended by Act Sec. 13603(a)) The election applies only for income tax purposes; the application of FICA and FUTA is not affected.
The election must be made no later than 30 days after the first time the employee’s right to the stock is substantially vested, or is transferable, whichever occurs earlier. (Code Sec. 83(i)(4)(A), as added by Act Sec. 13603(a)) If the election is made, the income has to be included in the employee’s income for the tax year that includes the earliest of:
- (1) the first date the qualified stock becomes transferable, including, solely for this purpose, transferable to the employer;
- (2) the date the employee first becomes an “excluded employee” (i.e., an individual: (a) who is 1% owner of the corporation at any time during the 10 preceding calendar years; (b) who is, or has been at any prior time, the chief executive officer or chief financial officer of the corporation, or an individual acting in either capacity; (c) who is a family member of an individual described in item (a) or (b); or (d) who has been one of the four highest compensated officers of the corporation for any of the 10 preceding tax years;
- (3) the first date on which any stock of the employer becomes readily tradable on an established securities market;
- (4) the date five years after the first date the employee’s right to the stock becomes substantially vested; or
- (5) the date on which the employee revokes his or her election. (Code Sec. 83(i)(1)(B), as amended by Act Sec. 13603(a))
The election is available for “qualified stock” (defined in Code Sec. 83(i)(2)(A), as amended by Act Sec. 13603(a)) attributable to a statutory option. In such a case, the option is not treated as a statutory option, and the rules relating to statutory options and related stock do not apply. In addition, an arrangement under which an employee may receive qualified stock is not treated as a nonqualified deferred compensation plan solely because of an employee’s inclusion deferral election, or ability to make the election.
Deferred income inclusion also applies for purposes of the employer’s deduction of the amount of income attributable to the qualified stock. That is, if an employee makes the election, the employer’s deduction is deferred until the employer’s tax year in which, or with which, ends the tax year of the employee for which the amount is included in the employee’s income as described in items (1) through (5) above.
The new election applies for qualified stock of an eligible corporation. A corporation is treated as such for a tax year if: (1) no stock of the employer corporation (or any predecessor) is readily tradable on an established securities market during any preceding calendar year, and (2) the corporation has a written plan under which, in the calendar year, not less than 80% of all employees who provide services to the corporation in the U.S. (or any U.S. possession) are granted stock options, or RSUs, with the same rights and privileges to receive qualified stock (the “80% rule”). (Code Sec. 83(i)(2)(C), as amended by Act Sec. 13603(a))
Detailed employer notice, withholding, and reporting requirements also apply with regard to the election. (Code Sec. 83(i)(6), as amended by Act Sec. 13603(a))
As noted above, the income deferral election generally applies with respect to stock attributable to options exercised, or RSUs settled, after December 31, 2017. However, under a transition rule, until IRS issues regs or other guidance implementing the 80% rule and employer notice requirements under the provision, a corporation will be treated as satisfying those requirements if it complies with a reasonable good faith interpretation of the requirements. The penalty for a failure to provide the notice required under the provision applies to failures after December 31, 2017. (Code Sec. 6652)(p), as amended by Act Sec. 13603(e))
Limitation on Excessive Employee Compensation
A deduction for compensation paid, or accrued, with respect to a covered employee of a publicly traded corporation, is limited to no more than $1 million per year. However, under pre-Act law, exceptions applied for: (1) commissions; (2) performance-based remuneration, including stock options; (3) payments to a tax-qualified retirement plan; and (4) amounts that are excludable from the executive’s gross income.
New law. For tax years beginning after December 31, 2017, the exceptions to the $1 million deduction limitation for commissions and performance-based compensation are repealed. The definition of “covered employee” is revised to include the principal executive officer, the principal financial officer, and the three other highest paid officers. If an individual is a covered employee with respect to a corporation for a tax year beginning after December 31, 2016, the individual remains a covered employee for all future years. (Code Sec. 163(m), as amended by Act Sec. 13601)
Under a transition rule, the changes do not apply to any remuneration under a written binding contract which was in effect on November 2, 2017, and which was not modified in any material respect after that date. Compensation paid pursuant to a plan qualifies for this exception if the right to participate in the plan is part of a written binding contract with the covered employee in effect on November 2, 2017. The fact that a plan was in existence on November 2, 2017 isn’t by itself sufficient to qualify the plan for the exception. The exception ceases to apply to amounts paid after there has been a material modification to the terms of the contract. The exception does not apply to new contracts entered into, or renewed, after November 2, 2017. A contract that is terminable, or cancelable unconditionally at will by either party to the contract without the consent of the other, or by both parties to the contract, is treated as a new contract entered into on the date any such termination or cancellation, if made, would be effective. However, a contract is not treated as so terminable, or cancellable, if it can be terminated or cancelled only by terminating the employment relationship of the covered employee.
Stock Compensation of Insiders in Expatriated Corporations
An excise tax is imposed on the value of the specified stock compensation held by disqualified individuals if a corporation expatriates, and gain on any stock in the expatriated corporation is recognized by any shareholder in the expatriation transaction. Under pre-Act law, the excise tax was 15% of the value of the specified stock compensation (i.e., payments with a value that is based on (or determined by reference to) the value (or change in value) of stock in the corporation) held (directly or indirectly) by, or for the benefit of, the individual or a member of the individual’s family during the 12-month period beginning six months before the expatriation date.
New law. For corporations first becoming expatriated corporations after the date of enactment of the Act, the excise tax on stock compensation in an inversion is increased from 15% to 20%. (Code Sec. 4985(a)(1), as amended by Act Sec. 13604)
Excise Tax on Excess Tax-Exempt Organization Executive Compensation
Under pre-Act law, there were reasonableness requirements, and a prohibition against private inurement, with respect to executive compensation for tax-exempt entities, but no excise tax tied to the amount of compensation paid.
New law. For tax years beginning after December 31, 2017, a tax-exempt organization is subject to a tax at the corporate tax rate (21% under the Act) on the sum of: (1) the remuneration (other than an excess parachute payment) in excess of $1 million paid to a “covered employee” by an applicable tax-exempt organization for a tax year; and (2) any excess parachute payment paid by the applicable tax-exempt organization to a covered employee. A “covered employee” is an employee (including any former employee) of an applicable tax-exempt organization, if the employee is one of the five highest compensated employees of the organization for the tax year, or was a covered employee of the organization (or a predecessor) for any preceding tax year beginning after December 31, 2016. Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to the remuneration. (Code Sec. 4960, as amended by Act Sec. 13602)
Repeal of ACA Individual Mandate
Under pre-Act law, ACA required that individuals who were not covered by a health plan that provided at least minimum essential coverage, were required to pay a “shared responsibility payment” (also referred to as a “penalty”) with their federal tax return. Unless an exception applied, the tax was imposed for any month that an individual did not have minimum essential coverage.
New law. For months beginning after December 31, 2018, the amount of the individual shared responsibility payment is reduced to zero. (Code Sec. 5000A(c), as amended by Act Sec. 11081) Reducing the penalty to zero effectively repeals the individual mandate, and is permanent.
RIA observation: According to the Congressional Budget Office (CBO), reducing the penalty to zero would raise approximately $338 billion over the 10-year budgetary window period because, when no longer penalized for not doing so, fewer people would obtain subsidized coverage.
RIA observation: The Act leaves intact the 3.8% net investment income tax and the 0.9% additional Medicare tax, both provided under ACA.
Qualified Bicycle Commuting Exclusion Suspended
Under pre-Act law, an employee was allowed to exclude up to $20 per month in qualified bicycle commuting reimbursements—i.e., any amount received from an employer during a 15-month period beginning with the first day of the calendar year, as payment for reasonable expenses during a calendar year.
New law. For tax years beginning after December 31, 2017, and before January 1, 2026, the exclusion from gross income and wages for qualified bicycle commuting reimbursements is suspended. (Code Sec. 132(f)(8), as added by Act Sec. 11047)
Employer’s Deduction for Fringe Benefit Expenses Limited
Under current law, a taxpayer may deduct up to 50% of expenses relating to meals and entertainment. Housing and meals provided for the convenience of the employer on the business premises of the employer are excluded from the employee’s gross income. Various other fringe benefits provided by employers are not included in an employee’s gross income, such as qualified transportation fringe benefits.
New law. For amounts incurred, or paid, after December 31, 2017, deductions for entertainment expenses are disallowed, eliminating the subjective determination of whether such expenses are sufficiently business related; the current 50% limit on the deductibility of business meals is expanded to meals provided through an in-house cafeteria or otherwise on the premises of the employer; and deductions for employee transportation fringe benefits (e.g., parking and mass transit) are denied, but the exclusion from income for such benefits received by an employee is retained. In addition, no deduction is allowed for transportation expenses that are the equivalent of commuting for employees (e.g., between the employee’s home and the workplace), except as provided for the safety of the employee.
For tax years beginning after December 31, 2025, the Act will disallow an employer’s deduction for expenses associated with meals provided for the convenience of the employer on the employer’s business premises, or provided on or near the employer’s business premises through an employer-operated facility that meets certain requirements. (Code Sec. 274, as amended by Act Sec. 13304)
Employee Achievement Awards
Employee achievement awards are excludable to the extent the employer can deduct the cost of the award—generally limited to $400 for any one employee, or $1,600 for a “qualified plan award.” An employee achievement award is an item of tangible personal property given to an employee in recognition of either length of service, or safety achievement, and presented as part of a meaningful presentation.
New law. For amounts paid or incurred after December 31, 2017, a definition of “tangible personal property” is provided. Tangible personal property does not include cash, cash equivalents, gifts cards, gift coupons, gift certificates (other than where the employer pre-selected or pre-approved a limited selection) vacations, meals, lodging, tickets for theatre or sporting events, stock, bonds or similar items, and other non-tangible personal property. No inference is intended that this is a change from present law and guidance. (Code Sec. 274(j), as amended by Act Sec. 13310)
New Credit for Employer-Paid Family and Medical Leave
Under pre-Act law, no credit is provided to employers for compensation paid to employees while on leave.
New law. For wages paid in tax years beginning after December 31, 2017, but not beginning after December 31, 2019, the Act allows businesses to claim a general business credit equal to 12.5% of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave (FMLA) if the rate of payment is 50% of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%. All qualifying full-time employees have to be given at least two weeks of annual paid family and medical leave (all less-than-full-time qualifying employees have to be given a commensurate amount of leave on a pro rata basis). (Code Sec. 45S, as amended by Act Sec. 13403)