November 2017 – USA – Proposed changes to US Tax Rules for Incentives

The US Tax Bill was released last week (read here). Although the Bill is still in the early stages of its passage through the US legislative process, we wanted to alert you to two proposed changes which, if adopted, will have significant implications for any equity incentive plans which operate in the US.

What changes are proposed?

  • Repeal of section 409A: section 409A has allowed US taxpayers to pay tax when the cash or shares are actually paid rather than when there is no longer a substantial risk of forfeiture (“US Vesting”). A new section 409B is proposed, under which deferred compensation will be taxed at US Vesting rather than when the compensation is actually paid.
  • Elimination of the performance-based compensation exception to section 162(m): the deductions which companies can claim in relation to compensation may be further restricted.

Remind me, why is section 409A important?

Section 409A sets out the conditions under which a US tax payer can defer the payment of tax on compensation which the employee earns in one year but does not receive until a later year (called “non-qualified deferred compensation”). Strict (and complicated) rules apply, but for equity incentive plans, that comply with or are exempt from section 409A, employees are able to defer the payment of tax until the benefit is actually received by the employee. It is very common for global share plans that include US participants to specify that awards made under the plan will comply with or be exempt from section 409A.

What impact will section 409B have on US employees?

The proposed section 409B would tax all non-qualified deferred compensation plans at US Vesting. The effect of this may be to require US employees to pay tax on share plan benefits before they have received the income. The Bill would generally apply to services performed from 2018.

And section 162(m)?

Section 162(m) of the Code prohibits public companies from deducting from their federal income taxes more than USD1 million per executive per year in compensation paid to ‘”covered employees”. Currently “qualified-performance based” compensation is specifically excluded from the section 162(m) limit – but it will be caught under the proposed changes.

In addition, payments to the chief financial officer, who is not currently a covered employee, will be included. Under the new rules, any person who becomes a covered employee for any taxable year beginning after 31 December 2016 would continue to be a covered employee in subsequent years – so severance pay will be subject to the cap.

Tapestry comment:

If the section 409A/409B changes are passed, this will require companies to review all of their plans which include any US taxpayers. Among other things, it has been suggested that the changes will spell the end of stock options.

The Republican Bill eliminates the performance pay loophole which applies to deductions. However, many believe that the USD1 million cap should be have been extended beyond the top executives to all employees, as proposed by the Democratic Party.

The Bill has also been criticised for its proposed federal corporate tax rate cuts, which would cost significantly more than the loophole-closing would generate. The beneficial tax rate provisions are also criticized as being overly complicated.

The Bill remains subject to negotiation, and it is uncertain if it will be passed in its current form. We will be watching and will update you once the Bill becomes law.

If you have any questions, please do get in touch – we are delighted to help!

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