2018 has been a year of significant legislative and regulatory activity in the areas of employee benefits and executive compensation. The Tax Cuts and Jobs Act (TCJA or the Act) alone included many provisions that affect the tax treatment in these areas. In addition, the Bipartisan Budget Act of 2018 (BBA) included employee benefit provisions. Currently, Congress is once again considering legislation that would affect the Affordable Care Act (ACA). Furthermore, one of the bills in Tax Reform 2.0 includes provisions to expand the section 529 college savings accounts and repeal the maximum age for IRA contributions. It was passed by the House in late September. With all of that said, the following topics of interest will be important for you to consider both for 2018 year-end tax planning as well as into the future.
- Roth recharacterization: Converting a traditional IRA to a Roth IRA provides taxpayers with the opportunity to hedge against future higher income tax rates. At the time of the conversion to the Roth IRA, the taxpayer pays income tax on the value of the account; however, future increases in value are not subject to income tax thereby enabling the taxpayer to have tax-free withdrawals in retirement. A Roth recharacterization reverses the Roth IRA conversion. There are several reasons for doing this:
- the value of investments in the converted Roth IRA declined since the date of the conversion;
- higher-than-expected taxable income and/or the additional income from the Roth IRA conversion resulted in a bump to a higher federal income tax bracket;
- taxable income in retirement will likely be lower than expected, reducing the potential benefits of a Roth IRA’s tax-free distributions; and
- not enough cash on hand to pay the taxes resulting from the conversion.
- Employer Credit for Paid Family and Medical Leave: The TCJA created a new general business tax credit for employers that voluntarily offer up to 12 weeks of paid family and medical leave annually to qualifying employees. The amount of the tax credit is 12.5 percent if the leave benefit amount equals 50 percent of normal pay. The credit increases 0.25 percent, up to a maximum of 25 percent. The credit is a specified credit that may reduce the alternative minimum tax. It is available to employers regardless of their number of employees. To qualify for this credit, the employer must have a written policy, and provide at least two weeks’ annual paid family and medical leave at a minimum of 50 percent of the employee’s wages. The credit is available on a temporary basis. Unless extended by Congress, it applies only with respect to wages for an eligible family and medical leave paid in taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2020.
- Qualified transportation fringe benefits: Qualified transportation fringe benefits include parking (parking on or near the employer’s business premises, or on or near a location from which the employee commutes to work by public transit) and the associated expenses, transit passes and vanpool benefits. A for-profit employer that offers its employees qualified transportation fringe benefits as pre-tax benefits is no longer allowed a corresponding tax deduction. A tax-exempt employer that offers these benefits may have a corresponding increase in its unrelated taxable income. The effective date of these provisions is Jan. 1, 2018.
- Bicycle commuting expenses: The TCJA also suspends the $20 per month employee tax exclusion for reimbursement of bicycle commuting expenses. Therefore, employer reimbursements for bicycle commuting expenses are taxable to the employee and subject to payroll and income tax withholding. This provision is effective for amounts paid or incurred between Jan. 1, 2018, and Dec. 31, 2025.
- Executive compensation – for-profit companies: Effective as of Jan. 1, 2018, the TCJA expanded the scope of the $1 million executive compensation deduction limitation. In addition to publicly traded corporations, it now applies to nonpublic companies with publicly traded debt. The covered employee group was broadened to include the CEO and CFO and the three highest-paid officers (other than the CEO or CFO), and to eliminate the “last day of the year” requirement. Under the new rules, once a covered employee, always a covered employee regardless of employee status or death. The TCJA also eliminated the performance-based compensation exception to the $1 million deduction limitation. However, the changes to the performance-based exception will not apply to compensation payable under a written binding contract which was in effect Nov. 2, 2017, provided the contract is not materially modified after that date.
- Executive compensation – tax-exempt organizations: The TCJA added a new excise tax at the corporate tax rate of 21 percent on excess executive compensation by applicable tax-exempt organizations as well as nonpublic companies that have public debt. The tax is applicable to remuneration paid to a covered employee that exceeds $1 million in a tax year and excess parachute payments upon separation from employment. This new law is intended to put tax-exempt organizations in the same position as publicly held companies already subject to limits on the deductibility of high compensation amounts paid to certain executives. It also puts nonpublic companies that have public debt in an equivalent situation to that of public companies. The excise tax does not apply to remuneration made to licensed medical professionals (physicians, nurses and veterinarians), but only to the extent compensation payments relate directly to performance of medical services.
- Special 401(k) plan contributions tied to student loan repayment: The IRS recently approved an employer’s proposal to offer a student loan repayment program as a component of its 401(k) plan. The ruling essentially allows employees to receive the equivalent of matching contributions without electing to make their own contributions. Although the ruling is binding only by the employer that sought the ruling, it does provide welcome guidance to employers seeking to provide employees with the opportunity to save for retirement on a tax-deferred basis while repaying their student loans. Employers who wish to add this feature may want to request their own private letter ruling from the IRS, especially if the design differs from the provisions approved in the ruling. In addition, employers who use a prototype or volume submitter plan document are limited by features that may be added and may have to change to an individually designed plan until the IRS issues regulatory guidance.
- Expansion of multiple employer plans (MEPs): Treasury and the Department of Labor will be considering the expansion of MEPs, also known as association retirement plans, to enable groups of smaller employers to band together to offer a retirement plan to their employees while sharing the cost and responsibility with other employers. Treasury will also consider issuing guidance on removing a noncompliant employer to reduce the risk of plan disqualification when one of the participating employers fails to follow the tax-qualification requirements.
- Hardship withdrawals from retirement plans: Hardship withdrawals from 401(k) and 403(b) retirement plans became easier under the BBA. The BBA removed the six-month prohibition on deferrals after a participant takes a hardship withdrawal. It also eliminated the requirement that participants first take a loan from their plan account before taking a hardship withdrawal. These provisions could help an individual with a financial need continue saving for retirement without interruption as well as not having to forgo the employer matching contribution. These provisions of the BBA are effective for plan years beginning after Dec. 31, 2018.
- Rollover of retirement plan loans: Participants who have a loan outstanding at the time of plan termination or severance from employment have a longer timeframe to pay the amount of an outstanding plan loan to another qualified plan or an IRA in order to accomplish a tax-free rollover of the loan amount. If the unpaid loan balance was not repaid, it would become a taxable distribution subject to the 10 percent additional income tax on early distributions, unless an exception applies. This provision is effective as of Jan. 1, 2018.
- Required minimum distributions (RMDs): The Treasury Department will be looking into increasing the life expectancy estimates it uses to calculate how much money retirees have to take out of their 401(k) plans and IRAs after a certain age. Increasing the life expectancy rates or “mortality tables” associated with the minimum distribution rules would lower the amount of money a retiree is required by law to take out of 401(k)s or individual retirement accounts after the person reaches age 70 1/2. Treasury may choose to update the mortality tables if it determines the tables currently used do not reflect the correct life expectancy. In addition, Congress is considering legislation, the Family Savings Act of 2018, which would exempt retirees with less than $50,000 in retirement savings from minimum distributions entirely.
- ACA: The Save American Workers Act of 2018, H.R. 3798, if enacted, would change the ACA employer mandate threshold for full-time employees to 40 hours per week from 30 hours per week and would grant retroactive relief from the employer mandate. Thus, any employer would no longer owe a penalty for failing to meet the coverage requirements between Jan. 1, 2015, and Dec. 31, 2018. It would also provide a one-year delay, to Dec. 31, 2022, of the implementation of the ACA’s so-called Cadillac tax on high-cost health plans. In addition, beginning in 2019, employers would only be required to provide Form 1095 coverage statements for purposes of complying with the individual mandate to individuals upon request.
- FICA taxation rules for nonqualified deferred compensation: We see numerous instances where employers are not taking into account deferred compensation for Federal Insurance Contributions Act (FICA) at the appropriate time. The FICA “special timing rule” requires that the deferred compensation must generally be taken into account at the later of the time of the performance of services and at such time when there is no longer a “substantial risk of forfeiture” in entitlement to the benefit. This is usually when the benefit becomes vested. This, of course, is in contrast to the SECA (Self-Employment Contributions Act) rules that generally require the deferred compensation be taken into account upon actual or constructive receipt of the benefit. Employers should be focused on making sure that the deferred compensation, even if not distributed, is taken into account correctly in accordance with this special timing rule in a setting that requires payment of FICA taxes.
- Proposed regulations interpreting section 457 rules: In the summer of 2016, the Treasury Department issued proposed regulations interpreting the deferred compensation rules which apply to tax-exempt organizations and governmental subdivisions. These proposed regulations primarily addressed issues attendant with the granting and administration of “ineligible plans of deferred compensation” and were slated to become effective until following such time that final regulations were issued. As of the time of this writing, we have seen no activity by the administration suggesting these regulations will be finalized anytime soon. Therefore, for the present, we are regarding these proposed regulations solely as an indication of the Internal Revenue Service’s interpretation of certain income tax issues attendant with the application of these deferred compensation rules.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.