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November 10, 2017
Amendments to the Tax Cuts and
Jobs Act; Senate Version of
Senate Republicans unveiled their version of the tax bill (the
"Senate Bill"). This comes one week after House
Republicans first introduced the Tax Cuts and Jobs Act (the
"House Bill"), the highlights of which were the topic of
our November 3, 2017 Alert, and can be read here. The House Bill has already been amended
twice, first on November 2nd and then again yesterday. In general,
the amendments to the House Bill preserved the tax breaks for
retirement saving and did not include any provisions limiting
employees' ability to make pre-tax contributions, but the House
reversed the controversial repeal of key nonqualified deferred compensation
provisions which promised to alter the deferred compensation
other hand, the Senate Bill modified the eligibility for age 50
catch-up contributions, repealed rules permitting additional employee
contributions to 403(b) and 457(b) plans, and introduced a
nonqualified deferred compensation provision substantially similar to
that which the House Bill ultimately removed. Like the House Bill,
the cornerstone of the Senate Bill is the reduction of the corporate
tax rate to 20%. However, this reduction is less aggressive under
Senate Republicans' authorship, delaying the change until 2019.
Under the House Bill, corporate tax cuts would take effect next year,
that no changes were made with respect to the Affordable Care Act in
either the House or the Senate versions of the tax bill, including
the request by President Trump to repeal the individual mandate.
to the House Bill
general, the two amendments made the following changes to the House
- Gave a
reprieve, until 2023, with respect to the exclusion for
dependent care assistance programs. In the initial version, the
exclusion for dependent care assistance programs would be
repealed beginning in 2018.
- Modified the
1.4% excise tax applicable to private colleges and
universities. It provided that the 1.4% excise tax on the
net investment income would only apply if the fair market value
of the institution's endowment assets (other than those assets
used directly in carrying out its exempt purpose) that are
formally held by organizations related to the institution is at
least $250,000 per student.
the deferred recognition of income from the exercise of stock
options or restricted stock units (RSUs) for up to five years,
if such stock is not publicly traded.
that RSUs are not eligible for section 83(b) elections under the
Internal Revenue Code (the "Code").
- Struck the
proposed changes to nonqualified deferred compensation in the
initial version of the House Bill in their entirety, thereby
preserving their current-law tax treatment.
revised the taxation of small business pass-throughs with active
income. There is a phased-in 9% tax rate beginning in 2022 (11%
in 2018 and 2019, 10% in 2020 and 2021) for the first $75,000 in
net business income of an owner or shareholder with less
than $150,000 off taxable income through a pass-through
business (different dollar amounts apply for unmarried and heads
of household, but the same principle applies). Businesses of all
types are eligible for the preferential 9% rate, and such rate
applies to all business income up to $75,000.
the current-law tax treatment for qualified adoption expenses
and moving expenses for members of the Armed Forces on active
duty who move pursuant to a military order.
With respect to employee benefits, the Senate
Bill has a different focus, primarily making changes to 403(b) and
that age 50 catch-up contributions in 401(k), 403(b) and 457(b)
plans are not permitted if an employee received wages in excess
of $500,000 in the preceding year.
- Imposed a
10% early withdrawal penalty on distributions from governmental
457(b) plans. This penalty did not previously exist for
- Repealed the
o The special rule allowing employee contributions
to a 403(b) plan for five years after the employee's termination
of employment; and
o The special rules allowing additional elective
contributions and catch-up contributions in 403(b) and 457(b)
a single aggregate limit for contributions to an employee in a
governmental 457(b) plan and elective deferrals for the same
employee under a section 403(b) plan or 401(k) plan of the same
employer. This means that employees in a 457(b) plan will
no longer be able to contribute twice the elective deferral
limit in section 402(g) of the Code.
- For purposes
of the limits on annual additions to a defined contribution plan
under Code section 415, introduced a single aggregate limit for
employee contributions to any qualified defined contribution
plan such as a 401(k) plan, a section 403(b) plan, and a 457(b)
plan maintained by the same employer (including members of a
controlled group or affiliated service group).
One area addressed in the Senate Bill which was
not addressed by the House Bill is the appropriate classification of
workers in a gig economy -- one in which temporary positions are
common and organizations contract with independent workers for short
term projects -- as employees or independent contractors. Properly
classifying these members of the workforce has proved difficult under
existing standards. To address this issue, the Senate Bill introduced
a worker classification safe harbor whereby the (i) the service
provider is not treated as an employee, (ii) neither the service
recipient nor the payor for such services is treated as an employer,
and (iii) the compensation paid or received for the service is not
treated as paid or received with respect to employment.
For the safe harbor to apply, the service
provider generally must meet the following conditions: (i) incur
expenses which are deductible as a trade or business expense and a
significant portion of which are reimbursed; (ii) agree to perform
the service for a particular amount of time, to achieve a specific
result, or to complete a specific task; and (iii) have a significant
investment in assets or training applicable to the service performed,
not be required to perform services exclusively for the service
recipient, have not performed substantially the same services for the
service recipient or the payor as an employee during the one-year
period ending with the date of commencement of services under a
contract, the term of which may generally not exceed two years, or
not be compensated on a basis which is tied primarily to the number
of hours actually worked. For a service provider engaged in the
trade or business of selling (or soliciting the sale of) goods or
services, in lieu of conditions (i), (ii) and (iii) above, the
service provider must be compensated primarily on a commission basis,
and substantially all of the compensation for the service must be
directly related to the sale of goods or services rather than the
number of hours worked. In addition, any service provider must
(iv) have a principal place of business, must not primarily provide
the service in the service recipient's place of business, must pay a fair
market rent for use of the service recipient's place of business, or
must provide the service primarily using equipment supplied by the
service provider. Also, the service recipient under the
contract would be required to withhold 5% of the compensation
paid under the contract not to exceed $20,000.
The safe harbor would be available with respect
to services performed after December 31, 2017, and amounts paid for
services after such date.
Nonqualified Deferred Compensation Plans
As previously mentioned, amendments to the House
Bill eliminated the newly proposed section 409B which would radically
change the manner in which nonqualified deferred compensation is
treated. However, the Senate Bill contains a substantially
similar provision to section 409B. Under the proposal, without regard
to the service provider's method of accounting, any compensation
under a nonqualified deferred compensation arrangement is includible
in income when there is no "substantial risk of
forfeiture". A substantial risk of forfeiture is limited
to the service provider's right to receive the compensation being
conditioned on the future performance of substantial services.
Nonqualified deferred compensation arrangements
are broadly defined. While there are exceptions for qualified
retirement plans, bona fide vacation leave, sick leave, compensatory
time, disability pay, and death benefit plans, there are no
exceptions for severance plans (and the IRS is precluded from making
any exception for severance plans, bona fide or otherwise). It also
includes stock appreciation rights, nonqualified stock options, and
restricted stock units, but not incentive stock options or stock
under a qualified stock purchase plan under Code section 423.
Like the House Bill, the proposal also removes
from the Code, with respect to services performed after December 21,
2017, Sections 409A, 457(b) (for tax exempt employers), 457(f) plans
of state and local governments and tax-exempt employers, and
457A. As was the case with the House Bill, this Senate
provision presents a current operational issue for plan sponsors
obtaining elections with respect to 2018 services under existing
nonqualified deferred compensation arrangements. It may be necessary
to communicate to participants in such plans that, because of the
uncertainty as to future law, such deferrals may not be given effect.
With respect to "grandfathered" amounts
(i.e, amounts attributable to services performed before
January 1, 2018), such amounts are includible in income in the later
of (1) the last taxable year before 2027, or (2) the taxable year in
which there is no substantial risk of forfeiture. The Treasury
is also directed to provide guidance with respect to a limited period
of time during which existing nonqualified deferred compensation
arrangements can be modified to conform to the Senate proposal,
without violating the existing 409A rules with respect to modifying
the date of distribution.
Other changes in the Senate Bill relating to
nonqualified compensation matters are similar, but not identical, to
those in the House Bill.
- With respect
to the $1 million deduction limit on compensation paid to
"covered employees" available to publicly traded
companies, the definition of "covered employee" under
Code section 162(m) would be modified. A covered employee
would include both the principal executive officer and the
principal financial officer, including any individual who has
served in such capacities during the taxable year, and the three
highest compensated employees for the tax year required to be
reported on the company's proxy statements. The effect of this
change would be to include five individuals as covered
employees, rather than four. Further, if an individual is a
covered employee with respect to a corporation for a taxable
year beginning after December 31, 2016, the individual would
remain a covered employee for all future years. The proposal
would also extend the applicability of Code section 162(m) to
include all domestic publicly traded corporations and all
foreign companies publicly traded through ADRs, and would also
include additional corporations that are not publicly traded,
such as large private C or S corporations. Finally, the proposal
would eliminate the exceptions for commissions and
performance-based compensation from the definition of
compensation subject to the $1 million compensation limitation.
- A tax-exempt
organization would be subject to a 20% excise tax on the sum of
(1) the compensation (other than an excess parachute payment) in
excess of $1 million paid to any of its five highest paid
employees for the tax year or any employee who was one of the
five highest paid employees for any preceding taxable year after
2016, and (2) any excess parachute payment. Excess parachute
payment would be redefined for this purpose. This means that the
excise tax would apply even if the individual's compensation
does not exceed $1 million. This proposal would subject
tax-exempt organizations to a modified version of the Code's
present golden parachute requirements.
The Senate plan would retain the existing seven
tax brackets for individuals, instead of taking the House approach
which would consolidate them into four tax brackets. In
general, a 12% bracket would replace the existing 15% bracket,
while the existing top rate of 39.6% would be reduced to 38.5%.
Like the House Bill, the standard deduction
would be increased to $24,000 for joint filers (and surviving
spouses), $12,000 for single filers and $18,000 for heads of
household. The Senate Bill would also eliminate federal
deductions for state and local income taxes, just as the House Bill
would do. However, the Senate eliminated the property tax
deduction, while the House version allowed the deduction of property
taxes up to $10,000. The Senate left the interest deduction for
mortgages for new homes and the deduction for charitable
contributions unaffected. (The House Bill proposed to cap the
mortgage interest deduction at a loan value of $500,000.) The
alternative minimum tax would also be repealed under the Senate Bill.
Tax Deductions and Exclusions
- No deduction
for qualified transportation fringe benefits, but an employee is
still permitted to make pre-tax contributions to such plans.
- Repeals the
deduction and exclusion for qualified moving expenses, except
with respect to exclusions attributable to in-kind moving and
storage (and reimbursements or allowances for these expenses)
for members of the Armed Forces or their spouse or dependents.
deduction for medical expenses would be preserved.
exclusion for adoption assistance would be preserved.
exclusion for dependent care would be retained.
- The exclusion
for qualified bicycle commuting expenses would be repealed.
exclusion for educational assistance was unaffected by the
deduction and exclusion available with respect to an Archer
Medical Savings Account are preserved.
The Senate Bill doubles the estate and gift tax
exemption amount by doubling the basic exclusion amount (currently $5
million) to $10 million, which is indexed for inflation after 2011.
Unlike the House Bill, the Senate Bill does not eliminate the estate
Like the House proposal, the Senate Bill proposes
several modifications to the rules governing exempt organizations,
including subjecting certain private colleges and universities to a
1.4% excise tax on net investment income.
Corporate Tax Rate. Corporate tax rates would be lowered to a
flat 20% rate beginning in 2019, instead of in 2018 as was proposed
by the House. As we mentioned in our prior Alert, one consequence of
this is that expenditures would be more valuable under the current
Code than under the modified Code.
Pass-Through Rate. With respect to the treatment of pass-through
income by businesses, unlike the House Bill which focused on the rate
at which such income would be taxed, the Senate Bill would allow
individuals to deduct 17.4% of domestic qualified business income
from a partnership, S corporation or sole proprietorship effective
for taxable years beginning after December 31, 2017. The deduction
would not be available to specified service trades or businesses,
defined in the same manner as under the House Bill, except in the
case of a married taxpayer whose taxable income did not exceed
$150,000 ($75,000 for other individuals), phased out above these
With respect to the qualified business income of
an S corporation or partnership, the amount of the deduction would be
limited to 50% of the taxpayer's W-2 wages. For S corporations,
qualified business income would not include any amounts treated as
reasonable compensation to the taxpayer, and for partnerships
qualified business income would not include amounts allocated or
distributed to a partner acting other than in his or her capacity as
partner for services, and guaranteed payments for services actually
rendered to a partnership, to the extent that the payment is in the
nature of remuneration for such services.
Conclusion - Reconciliation
If the House and Senate pass separate tax bills,
lawmakers will need to work together to reconcile them and there's no
telling what the final product will look like. This may be a tall
order in light of the tight timeframe they have set for
themselves. Republicans have targeted the end of 2017 to
overhaul the U.S. tax system.