On December 22, 2017, President Trump signed a far-reaching overhaul of the Internal Revenue Code (IRC) (New Tax Law1). The New Tax Law significantly cuts the tax rates for corporations and partnerships permanently and temporarily modifies the individual income tax brackets, standard deduction and exclusions.
In the benefits area, it effectively repeals the individual shared responsibility penalty of the Affordable Care Act by making it zero and eliminates the ability of employers to deduct many employment-related fringe benefits. The New Tax Law also modifies the deduction rules for public companies with respect to executives earning over $1 million and creates a new 21 percent excise tax on nonprofits that pay compensation in excess of $1 million.
Earlier versions of the proposed new tax legislation included numerous provisions affecting employer-sponsored health and retirement plans and individual retirement accounts (IRAs). The New Tax Law, as enacted, does not include most of those provisions, but some of the eliminated provisions could reappear in future legislation.
Most of the New Tax Law’s provisions are effective in 2018. A notable exception is the effective elimination of the Affordable Care Act individual shared responsibility penalty, which is not effective until 2019.
This Update discusses the employee-benefit related provisions and next steps for plan sponsors.
Most corporations and partnerships will pay tax at a lower rate in 2018. As a result, employers may consider accelerating retirement plan contributions so they can be deducted for 2017. (The deadline for applying contributions to 2017 is September 15, 2018 for employers with calendar-year plans and calendar-taxable years). Employers should discuss this with their Sibson consultant.
Many plans require a participant to repay the full outstanding balance of a plan loan immediately on separation from service or termination of the plan. If the participant does not repay the full outstanding balance, the unpaid balance is treated as a taxable distribution from the plan (“deemed distribution”). Prior to the New Tax Law, the participant would have had to roll over an equal amount into an individual retirement account (IRA) within 60 days of the deemed distribution to avoid being immediately taxed on the deemed distribution. The New Tax Law gives a participant more time to roll over an equal amount — until the date (including extensions) the participant has to file the income tax return for the year in which the deemed distribution occurred. The new rule applies to plan loan amounts that are treated as distributed from qualified retirement plans, 403(b) plans and governmental 457(b) plans by reason of the termination of the plan or the participant’s failure to meet the repayment terms of the loan because of severance from employment. The new rule is effective for amounts that are treated as distributions in taxable years beginning after December 31, 2017.
Prior to the New Tax Law, an individual who elected to convert a traditional IRA to a Roth IRA (to pay taxes immediately rather than upon distribution) had until the individual’s tax filing deadline to undo the election. This allowed an individual to avoid paying tax on a high stock price if the price later dropped. The New Tax Law eliminates the last step: the ability to recharacterize a Roth IRA back to a traditional IRA after having previously converting it to a Roth IRA. Earlier versions of the New Tax Law would have prevented the initial conversion also, but the final New Tax Law dropped that portion of the provision. The provision is effective for taxable years beginning after December 31, 2017.
The New Tax Law provides tax relief for certain retirement plan and IRA distributions taken on or after January 1, 2016 and before January 1, 2018 by an individual whose principal place of abode was located in a presidentially declared disaster area at any time in 20162 and who sustained economic loss. The provision is effective on the date of enactment. The relief is from the 10 percent premature distribution tax and, if a 401(k), 403(b) or 457(b) plan so provides, from in-service distribution restrictions. As long as the plan operates in accordance, no plan amendment is required until the last day of the first plan year beginning on or after January 1, 2018 (January 1, 2020 for governmental plans).
Several retirement plan provisions were considered in the legislative process, but were not included in the New Tax Law. They include provisions that would have substantially accelerated the taxation of non-qualified deferred compensation; eliminated pre-tax 401(k) and other “catch-up” contributions while allowing increased catch-up contributions on a Roth after-tax basis; reduced the age for in-service distributions from certain plans to age 59½; modified rules for closed defined benefit plans; modified the rules for hardship distributions; subjected public pension plans to the unrelated business taxable income tax (UBIT) rules that currently apply to other not-for-profit entities; and limited special rules that allow participants in 403(b) and 457(b) plans to make additional contributions.
UnderIRC §162(m), before amendment, public companies were not allowed to deduct the compensation of certain executives to the extent it exceeded $1 million. Therefore, for purposes of this provision, compensation that was performance related, such as stock options and commissions, was ignored. The New Tax Law eliminates the exception for performance-based compensation. It also expands the definition of “public company,” and includes any person who was a “covered executive” after 2017 as a “covered executive” forever. The New Tax Law includes a transition rule grandfathering performance-related pay in a binding contract that was in effect on November 2, 2017. This provision applies for taxable years beginning after December 31, 2017.
The New Tax Law creates a new tax on compensation of certain tax-exempt organization executives. The tax is 21 percent of the sum of remuneration in excess of $1 million plus any excess parachute payments. The tax is paid by the tax-exempt organization. Covered employees are the five most highly compensated employees and those who were covered employees for any preceding tax year beginning after December 31, 2016. Remuneration does not include any amounts contributed to a Roth account. A parachute payment is a payment made at separation, and an excess parachute payment is the amount that is in excess of three times the base amount of the payment. (This is similar to the golden-parachute rules of IRC §280G.) This provision applies to taxable years beginning after December 31, 2017.
The New Tax Law allows certain employees who receive stock options or restricted stock units as compensation for performance of services to elect to defer income recognition for up to five years if the corporation’s stock is not publicly traded. This provision applies to stock attributable to options exercised or restricted stock units settled after December 31, 2017.
The New Tax Law changes the amount of the Affordable Care Act’s individual shared responsibility penalty for individuals who do not obtain health coverage to zero, effective in 2019. The elimination of the penalty is expected to save the government money because some low and moderate income workers would not buy health coverage; thus, they would not receive federal premium assistance tax credits. However, if fewer individuals obtain health insurance, uncompensated care costs could rise, leading indirectly to higher costs for employer plans as they subsidize these costs. In addition, the Congressional Budget Office (CBO) estimates that three million individuals could drop employer-sponsored health plans if they are not required to have coverage. The provision applies on or after December 31, 2018. Consequently, individuals who do not maintain coverage are subject to the individual shared responsibility penalty in 2018.
Although the individual shared responsibility penalty is effectively repealed, the New Tax Law does not repeal the employer shared responsibility penalty or any of the employer or health plan reporting obligations. Consequently, employers and health plans must continue to send Forms 1094-B and 1095-B to employees and participants, and to file copies with the Internal Revenue Service. The New Tax Law does not change the Affordable Care Act’s excise tax on high-cost health plans (commonly referred to as the Cadillac tax). Previous proposals as part of health reform would have delayed the Cadillac tax until 2026. Consequently, the Cadillac tax will still take effect in 2020. Other Affordable Care Act taxes that would have been repealed or delayed as part of health reform are also not addressed in the New Tax Law. These include the health insurance tax, medical device tax, cap on employee contributions to health Flexible Spending Arrangements (FSAs), and requirement that over-the-counter drugs be paid only with a prescription. The New Tax Law also makes no changes to Health Savings Accounts or Archer Medical Savings Accounts (MSAs). We expect that some of these items, particularly the health insurance tax, may be addressed in spending legislation in 2018.
Current law uses the Consumer Price Index for All Urban Consumers (CPI-U) as the measure for inflation adjustments of certain annual thresholds. The New Tax Law changes the measure of inflation adjustments to the Chained Consumer Price Index for All Urban Consumers (C-CPI-U). C-CPI-Uis a different measure of inflation than the CPI-U, and it generally results in slightly smaller annual indexing increases each year. Among the items that would be subject to the Chained-CPI-U are income tax brackets, IRAs, Health Savings Accounts (HSAs), Archer Medical Savings Accounts (MSAs), health Flexible Spending Arrangements (FSAs), the Cadillac tax and the Affordable Care Act’s premium assistance tax credits. (This change does not apply to cost-of-living increases based on IRC §415(d), which means that the CPI increase for most retirement plan limits are not reduced.)
Individuals may still elect to defer salary on a pre-tax basis for qualified transportation benefits. However, the employer deduction for expenses for qualified transportation benefits (parking, transit passes and vanpools) is repealed. Employers may still deduct expenses if they are necessary to ensure employee safety. Tax-exempt entities will be taxed on the value of providing qualified transportation benefits by treating the funds used to pay for the benefit as unrelated business taxable income (UBTI). The provision applies to amounts paid or incurred after December 31, 2017.
The New Tax Law repeals the exclusion for bicycle commuting expenses through 2025. Unlike the transportation benefit, employees cannot pay for bicycle commuting expenses on a pre-tax basis. The provision applies to taxable years beginning after December 31, 2017; it sunsets after 2025.
Employers can currently deduct the cost of employee achievement awards up to a certain dollar amount. The amount is also excluded from the employee’s income. The New Tax Law modifies the definition of “tangible personal property” that can be considered a deductible employee achievement award. Consequently, cash, cash equivalents, gift cards, gift coupons or certificates, vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds and similar items cannot be deducted. However, arrangements conferring only the right to select and receive property from a limited array of such items pre-selected or pre-approved by the employer may still be deductible. The provision applies to amounts paid or incurred after December 31, 2017.
The New Tax Law prohibits employer deductions for entertainment, amusement or recreation activities, and membership dues relating to a business, with certain exceptions. The provision applies to amounts incurred or paid after December 31, 2017.
The New Tax Law repeals the employer deduction and employee exclusion from income for employer-provided qualified moving expenses, but provides an exception for members of the U.S. Armed Forces on active duty who move pursuant to a military order. The provision is effective for taxable years beginning after December 31, 2017; it sunsets after 2025.
Previous versions of the bill would have eliminated Dependent Care Assistance Programs (DCAPs) and employer-provided child care credits. However, the New Tax Law did not change either program. Adoption assistance benefits and educational assistance plan benefits were also not changed.
The Tax Law creates a new employer tax credit for employers that pay employees who are on a leave under the Family and Medical Leave Act (FMLA), effective for wages paid in taxable years beginning in 2018 or 2019.
Eligible employers can claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees on FMLA leave. Employers must provide at least two weeks of leave and pay at least 50 percent of salary during the leave. The tax credit increases if employers pay a higher rate of wage replacement during the leave.
Employers must have a written policy to provide such leave. Any paid family leave required by state or local law, or provided as vacation, personal, or other medical or sick leave, would not qualify for the credit. For 2018, the credit can only be taken with respect to leave provided to employees who earn less than $72,000 annually (60 percent of the compensation threshold for highly compensated employees under IRC Section 414(g)).
Sibson works with plan sponsors and their legal counsel on compliance and design issues.
Sibson can work with you to determine whether you should be making additional contributions for 2017 and the proper timing of those contributions. For employer deductions that are modified, employers may wish to consult with their tax adviser as to the overall impact of the corporate tax modification and whether the tax decrease could offset any potential losses from elimination of the deductions.
Sibson can also assist employers to understand the impact of the new tax rules on their existing employee benefits and fringe benefit offerings. Employers may wish to discuss potential withholding changes with their payroll services providers and prepare employees for potential changes. Employers that offer a paid family leave benefit should review it to determine whether they can take advantage of the new tax credit and if so assure that written policies are in place.
For more information about how the New Tax Law may affect you, please contact your Sibson consultant or the Sibson office nearest you.
1 The official name is “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.” You might see it referred to in the press and other articles as the “Tax Cuts and Jobs Act.” This was its short title until final passage when the short title had to be dropped to conform with Senate rules.
Update is Sibson Consulting’s electronic newsletter summarizing compliance news. Update is for informational purposes only and should not be construed as legal advice. It is not intended to provide guidance on current laws or pending legislation. On all issues involving the interpretation or application of laws and regulations, plan sponsors should rely on their attorneys for legal advice.
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