March 11, 2014
Tax Reform
The Chairman of the House Ways and Means Committee has released a discussion draft of proposed legislation that could dramatically change the tax treatment of stock compensation as we know it. Here is a summary of the proposals.
No More Deferrals of Compensation
The good news is that Section 409A would be eliminated; I still don’t fully understand that section of the tax code and maybe if I just wait things out a bit, I won’t have to. But the bad news is that it would no longer be permissible to defer taxation of stock compensation beyond vesting. Instead, all awards would be taxed when transferable or no longer subject to a substantial risk of forfeiture.
This would eliminate all elective deferral programs for RSUs and PSUs. The NASPP has data showing that those programs aren’t very common, so you probably don’t care so much about that. On the other hand, according to our data, about 50% of you are going to be very concerned about what this will do to your awards that provide for accelerated or continued vesting upon retirement. In addition to FICA, these awards would be subject to federal income tax when the award holder is eligible to retire. Say goodbye to your good friends the rule of administrative convenience and the lag method (and the FICA short-term deferral rule)–those rules are only available when the award hasn’t yet been subject to income tax. This could make acceleration/continuation of vesting for retirees something we all just fondly remember.
As drafted, this proposal would also apply to stock options, so that they too would be subject to tax upon vest (the draft doesn’t say anything about repealing Section 422, so I assume that ISOs would escape unscathed). But one practitioner who knows about these things expressed confidence that there would be some sort of exception carved out for stock options. I have to agree–I don’t have data to support this, but I strongly suspect that the US government gets a lot more tax revenue by taxing options when they are exercised, rather than at vest (and that someone is going to figure this out before the whole thing becomes law).
Section 162(m) Also Targeted
The proposal also calls for the elimination of the exception for performance-based compensation under Section 162(m). This means that both stock options and performance awards would no longer be exempt from the deduction limitation. At first you might think this is a relief because now you won’t have to understand Section 162(m) either. I hate to rain on your parade, but this is going to make the tax accounting and diluted EPS calculations significantly more complex for options and performance awards granted to the execs subject to this limitation.
And that’s a bummer, because the proposal says that once someone becomes subject to the 162(m) limitation, they will remain subject to it for the duration of their employment. Eventually, you could have significantly more than five execs that are subject to 162(m). That’s right–five execs. The proposal would make the CFO once again subject to
And There’s More
The proposal would also change ordinary income tax rates, change how capital gains and dividends are taxed, and eliminate the dreaded AMT (making the CEP exam just a little bit easier). And those are just the changes that would impact stock compensation directly. There is a long list of other changes that will impact how you, your employees, and your employer are taxed. This memo by PwC has a great summary of the entire discussion draft. In addition, we are in the process of recording a podcast with Bill Dunn of PwC on the draft–look for it soon in the NASPP podcasts available on iTunes.
When Does This All Happen?
That’s a very good question. This proposal has a long ways to go on a road that is likely to be riddled with compromise. As far as I can tell, it hasn’t even been introduced yet as a bill in the House. It has to be passed by both the House and the Senate and then signed into law by the President. So I wouldn’t throw out those articles you’ve saved on Sections 409A and
– Barbara