The Trump Administration released its long-awaited tax reform proposal yesterday. The proposal is a long ways away from being final; legislation still has to be introduced into Congress and passed by both the House and the Senate, and the proposal, consisting of a single-page of short bullet points, is lacking in key details. The NY Times refers to it as “less a plan than a wish list” (“White House Proposes Slashing Tax Rates, Significantly Aiding Wealthy,” April 26, Julie Hirschfeld Davis and Alan Rappeport).
Here are six ways the proposal, if finalized, could impact equity compensation.
1. Lower Individual Tax Rates: The proposal would replace the current system of seven individual tax rates ranging from 10% to 39.6% with just three tax rates: 10%, 25%, and 35%. The plan doesn’t indicate the income brackets applicable to each rate, but it will clearly be a significant tax cut for many taxpayers (except those already in the lowest tax bracket).
Lower individual tax rates mean that employees take home a greater percentage of the income from their equity awards (and all other compensation). This will impact tax planning and may change employee behavior with respect to stock holdings and equity awards. Employees may be less inclined to hold stock to qualify for capital gains treatment and tax-qualified awards and deferral programs may be less attractive.
2. New Tax Withholding Rates: It’s not clear yet what would happen to the flat withholding rate that is available for supplemental payments. The rate for employees who have received $1 million or less in supplemental payments is currently pegged to the third lowest tax rate. But with only three tax rates, this procedure no longer makes sense.
The rate might stay at 25% or, with only three individual tax rates, the IRS might dispense with the supplemental flat rate altogether and simply require that companies withhold at the rate applicable to the individual. This could have the added benefit of resolving the question of whether to allow stock plan participants to request excess withholding on their transactions.
3. Lower Capital Gains Rate. The plan calls for elimination of the additional 3.8% Medicare tax imposed on investments that is used to fund Obamacare. This will increase the profit employees keep from their stock sales.
4. No More AMT. If you’ve been putting off learning about the AMT, maybe now you won’t have to. The plan would eliminate the AMT altogether (there aren’t any details, but I assume taxpayers would still be able to use AMT credits saved up from prior years). This would be a welcome relief for any companies that grant ISOs.
5. Elimination of the Estate Tax. With elimination of the estate tax, the strategy of gifting options to family members or trusts for estate-planning purposes would no longer be necessary.
6. Lower Corporate Tax Rate. The plan calls for the corporate tax rate to be reduced from 35% to 15%. A lower corporate tax will reduce corporate tax deductions for stock compensation, which will mitigate the impact of the FASB’s recent decision to require all tax effects for stock awards to be recorded in the P&L.
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 162(m), a change that’s probably long overdue.
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 162(m) and the AMT just yet. It’s hard to say what, if anything, will come of this.
On New Year’s Eve, as I was watching the various countdowns and celebrations on TV, I couldn’t help but notice the volume of interruptions and the stark contrast of “serious” reporting going on about the fiscal cliff negotiations. It was like watching two different television shows at once: celebrate, fiscal cliff, celebrate, fiscal cliff. All that reporting did lead to somewhere this time – a deal was eventually reached and passed shortly thereafter (formally known as “The American Taxpayer Relief Act 89-8”). Sorting through the outcomes has become the next challenge at hand. In today’s blog I’ll attempt to provide the current lay of the land for tax withholding in 2013.
For Many, A Reprieve
One of the big stories of the fiscal cliff doom scenario was that not only were some tax cuts expiring, but that there were so many of them slated to change all at once. The Bush Era income tax rates were set to expire and revert upward. The Social Security payroll tax holiday was coming to an end. New medicare rates were set to be introduced in 2013 for high earners and on certain types of income. So what’s the bottom line? What changed and what didn’t? The good news for many taxpayers is that it’s not as bad as it could have been, though some taxes will still increase. Higher earners will be impacted more, with increased federal rates.
Federal Withholding Rates: The American Taxpayer Relief Act effectively maintains the reduced income tax rates adopted in 2001 and 2003 for individuals earning up to $400,000 and families earning less than $450,000. Income above those levels will be taxed at 39.6%, up from 35%.
Social Security: The end of the road has come for the Payroll tax holiday of 2011 that was eventually extended through 2012. That means the 4.2% employee withholding rate that’s been in effect for the past two years has returned to 6.2% effective January 1, 2013. Employers have until February 15, 2013 to implement the new rate and until March 31, 2013 to make any adjustments related to rate implementation post effective date.
Medicare: The new medicare tax rate previously enacted remains in force and unchanged. Essentially, for income over a certain threshold, an additional 0.9% in medicare tax is withheld beginning with tax years after December 31, 2012. For more details, click here or visit our Tax Withholding and Reporting Portal.
Supplemental Income Withholding Rates: At this point, our eyes are looking for additional guidance from the Treasury Department on the status of supplemental income withholding rates. Our current thought is that the rate for supplemental payments below $1 million will stay at 25%, since this is tied to the third highest individual tax rate (which didn’t change), but that the rate for supplemental payments in excess of $1 million will increase to 39.6%, since this is tied to the highest individual tax rate. This interpretation is not based on any guidance from the Treasury, and we’ll have to wait until they release more information to confirm this component.
Timeframe to Implement
Companies have until February 15, 2013 to make the changes to withholding rates. It may make sense to move forward in making changes to known rates (like social security and medicare) as quickly as possible, and wait a bit longer to change other rates until the Treasury has issued further guidance on how the supplemental (and other) rate(s) will be affected. The IRS did release Notice 1036, which is essentially contains the rate tables to guide withholding for 2013, but that was on New Year’s Eve, before the Act was passed. As a result, their 2013 tables will need to be updated to reflect the withholding rates that are now in effect.
The NASPP is Hiring!
On a completely separate note, the NASPP is hiring! Check out our job listing in the NASPP Career Center for additional information.
I wish everyone a happy, healthy and prosperous new year!
The election is over, and I have to say I am thrilled. No, I’m not talking about the outcome (I’ll withhold my opinions there, since this is not a political blog, though I will say I think election night set a record in terms of the number of banter-by-text messages I exchanged with many friends and family.) I’m referring to the fact that I don’t have to hear a campaign ad every 30 seconds, everywhere I go, for a long, long time. Regardless of your political affiliation, I’m guessing you may agree. So now what? As I moved into the first day post Obama re-election, I found myself wondering about what was next. What’s going to happen to all those tax holidays? How about the impending fiscal cliff? Some of these things affect stock compensation directly, others peripherally. In today’s blog, I explore the impact of the election on some of these key issues, as relates to our world of stock compensation. I apologize in advance because it’s a long one this week, but sometimes it just ends up that way.
What’s What?
First, I leveraged an expert for today’s blog, Bill Dunn of PricewaterhouseCoopers. He’s spent a good part of the past several months doing presentations, including one at our recent NASPP Annual Conference, on the impact the election would likely have on a number of issues, like taxes (if you attended the conference, you have the slides from Session 6.2: “Election 2012! The Campaign Trail and Equity Compensation,” and if you didn’t attend or did and would like to hear the presentation, you can obtain the materials/audio on our web site.) Bill is the perfect source to add flavor to today’s blog, and I’ll refer to several of his insights and comments.
Let’s start by examining the makeup of Washington. The outcome of election 2012 was basically that the American people ratified the status quo. President Obama has won another four years in the White House, the Republicans still control the House, and the Senate remains in Democratic hands. In terms of the balance of power, we are in essentially the same place as we were before the election.
With the status quo in place, I asked Bill about what significant events would occur in the coming months, relative to taxes and equity compensation. Here’s what I learned:
Bush era tax cuts are set to expire December 31,
2012. Also set to expire are the current tax holidays, like that on FICA (which was temporarily reduced to 4.2%, down from 6.2%).
Automatic government spending cuts go into
effect in 2013, cutting the defense budget amongst other things.
The combination of the two points above result in a
worst-case scenario known as the “fiscal cliff”: reduced government spending
and increased taxes. Predictions include possibility of recession if
changes are not made.
· The retained balance of power in Washington presents
challenges in dealing with the fiscal cliff and future tax policy because:
o The President could sustain a veto
o The House will control tax legislation, and
o Either party could filibuster
(non-reconciliation) bills in the Senate
With huge tax and spending changes on the horizon, one primary concern is the abruptness of the change. You have a “perfect storm” of huge spending cuts coming together with huge tax increases all at once. So what’s on the table for each party in terms of a path to resolve this potential crisis? Most agree that some action is needed. Bill shared some
perspective on both parties’ stated views on the topic:
Democrat View:
Propose selectively eliminating the “Bush Tax
Cuts”
o Increase Ordinary income tax rate (top rate from
35% to 39.6%)
o Long-term capital gains increase from 15% to 20%
o Qualified dividends increase from 15% to 39.6%
o Associated supplemental income rates would
increase (28% up to $1M (from 25%), 39.6% for $1M+ (up from 35%))
Republican View:
No tax increases
Scenarios, Scenarios
With divided view points on how to
handle tax policy in Washington, what
are possible outcomes and when? Here are a few plausible scenarios:
Postpone action by extending all the tax cuts
and suspend spending cuts until Congress comes up with a solution in 2013
Temporary compromise on rate action before
December 31, 2012
o In this scenario, results would likely be skewed
towards Democrats’ terms and result in tax increases for upper income taxpayers
o Qualified dividends might stay aligned with
long-term capital gains rates, perhaps at a rate of 20% for certain taxpayers
o Tax rates could also rise for upper-income
taxpayers, but with redefinition to increase threshold ($1M?)
Republicans could hold fast to their anti-tax
increase pledge, presenting the “fiscal cliff”
o But maybe only until enough pain is felt by both
parties, enough blame is given to one party, or the government suffers a
promised downgrade in its debt rating by Moody’s.
Why Do I Care?
As a stock plan professional, the obvious question is “Why
do I care about all this government policy stuff?” While I’d like to just turn
my head for several months until something changes, I realize that the issues
on the horizon are significant and problematic for our economy and
taxpayers.As stock plan professionals,
we are directly involved in withholding ordinary income taxes and informing plan
participants about our withholding obligations. I’m not going to get into the
debate on “what” tax topics should be presented to employees (that’s for you
and your counsel to dissect). What I will suggest is that there is a vastly
different tax landscape slated for 2013 and beyond. If Congress does not take
action to make changes or extend tax cuts/holidays by December 31, 2012, these changes
will come to fruition, at least until further action is taken.I don’t recommend advising employees on the
timing of making a transaction (leave that to their advisers), but if the tax cuts expire, it’s likely that
some (if not all) participants will experience a material difference between
executing a stock transaction in 2012 vs. 2013 in terms of the tax impact. As a
result:
If
no action is taken to change rates or extend tax cuts, be ready for the
possibility of increased transactions towards year-end.
If
action is taken to change tax rates or extend tax cuts, then
stock plan professionals will need to be prepared to implement new or extend existing withholding
rates.
With a lot of uncertainty around what the future will hold
in terms of tax policy, one thing is certain: be prepared for changes, lots of
them. Not only will plan administrators likely have to adjust withholding rates, but the education
message to participants will need to be tweaked. For these reasons, I do care
about the impending fiscal cliff and how Congress intends to move forward.