Written by: Raul Fajardo, CEP
Update on the Tax Reform Bill (formerly known as the Tax Cuts and Jobs Act). The Senate approved their final version last week. The Senate and the House versions of the Bill have differences and need to be reconciled. Both the House and the Senate will appoint conferees to the conference committee this week and come up with a consolidated Bill.
Here are the updated potential changes directly affecting equity compensation:
1. Qualified equity grants – The proposal is to allow employees in privately held companies to elect to defer tax on stock options and RSUs until five years after the arrangements vest, provided certain conditions are met. Currently, they are taxed upon release or exercise after the blackout period following an IPO. Note: Both the House and Senate versions of the Bill have this provision.
2. Tax exemption of 162(m) grants – The proposal is to limit grants that are considered as exempt from 162(m), including stock option grants and performance grants that have a minimum payout of 0%. It also expands the list of individuals considered as individuals subject to 162(m) to include CFOs and covered individuals are part of 162(m) permanently. Currently, stock options and performance grants are exempt and companies can still get a tax deduction. CFOs are not included and covered individuals were part of 162(m) only on the year that they made the cut-off. The effect of this is that most executive equity compensation would no longer get a tax deduction. Note: Both the House and Senate versions of the Bill have this provision. Addendum: The Senate version of the Bill includes a transitional provision that would exempt compensation paid as of November 2, 2017. There is no transitional provision in the House bill, meaning all prior awards would be subject to the new rules.
3. Taxation of stock options and SARs – The proposal is to tax stock options and SARs at vest. Currently, they are taxed at exercise. Note: This provision was originally part of both the House and Senate versions but revised versions have taken it out.
4. Deferrals – The proposal is to collect tax at vest, regardless of when the shares are released. It means that all taxes are due at vest, FICA, Federal, and State. Currently, only FICA is due at vest, while Federal and State taxes are due at time of release. Note: This provision was originally part of both the House and Senate versions. Thankfully, both revised versions have taken this out.
Here are other changes in the tax law that affect individuals and have a downstream effect on equity compensation:
1. Individual tax brackets – The proposal is to change tax rates and tax brackets for individuals. The final version of the tax rates and brackets could then change the tax percentage collected for supplemental wages. Most, if not all of equity compensation withholding taxes are done at the supplemental tax rates. If the House version of the Bill passes, then the supplemental tax rate for wages under $1 million would be at 35%, whereas the Senate version would be at 22%. The current rate is at 25%. If the Senate version of the Bill passes, then the supplemental tax rate for wages over $1 million would be at 38%, whereas the House version keeps the top rate at 39.6%. The Senate version of the tax rates expires at 2025, the House version does not have a sunset provision.
2. Alternative minimum tax (AMT) – The House proposal is to repeal AMT. The Senate version keeps AMT but raises the exemption amounts and phase-out thresholds. Repealing AMT equalizes the field for ISOs vs NQs and could result in the increased usage of ISOs.
3. Corporate tax rates – The proposal is to change the tax rate to 20% from 35%. The House version is effective in 2018, the Senate version is effective in 2019.
4. Cost Basis – The Senate proposal is that securities sold on a FIFO basis while the House does not have this provision. Currently, you can assign the securities sold to a specific lot.
Certent is monitoring the developments on the Tax Reform Bill and will continue to provide updates.