On November 20, 2017, the Senate Finance Committee released the legislative text of its proposed version of the Tax Cuts and Jobs Act (the “Senate Finance Committee Bill”). The Senate Finance Committee Bill, like the version of the Tax Cuts and Jobs Act passed by the House on November 16 (the “House Bill”), would make changes to the executive compensation plans of for-profit and tax-exempt employers if it is enacted in its current form. This client alert covers key aspects of the proposed executive compensation changes in the Senate Finance Committee Bill.

Read our previous alerts summarizing the executive compensation changes proposed in the House Bill, and changes made to those provisions in Amendment #2 to the House Bill.

Executive Compensation of For-Profit Employers

The $1 million Deduction Limit under Section 162(m) of the Internal Revenue Code

1. Does the Senate Finance Committee Bill affect exemptions to the $1 million deduction limit under Section 162(m) of the Code?
   Section 162(m) of the Code prohibits a public company from deducting compensation paid to a “covered employee” in excess of $1 million per year. Currently, the $1 million deduction limit does not apply to performance-based compensation or to remuneration payable on a commission basis. Similar to the House Bill, the Senate Finance Committee Bill would repeal the performance-based compensation exception and the exception for remuneration payable on a commission basis.

2. Are there changes to the individuals who are subject to Section 162(m)?
   Currently, the principal financial officer (i.e., the CFO) of a public company is not considered a “covered employee” for purposes of the $1 million deduction limit of Section 162(m) of the Code. Similar to the House Bill, the Senate Finance Committee Bill would apply the $1 million deduction limit to a company’s principal financial officer and to any employee who was a covered employee in any preceding tax year beginning after December 31, 2016.

3. How about the entities that are subject to Section 162(m)?
   Similar to the House Bill, the Senate Finance Committee Bill would apply the $1 million deduction limit to companies that are required to file reports with the SEC under Section 15(d) of the Securities Exchange Act, such as a company that issues debt securities to the public.

4. When would these changes take effect?
   If the Senate Finance Committee Bill is enacted as currently drafted, the Section 162(m) changes would apply to taxable years beginning after December 31, 2017. However, the Section 162(m) changes would not apply to compensation payable pursuant to a written binding contract in effect on November 2, 2017, that is not modified in any material respect on or after that date.

5. Our Comment: The Section 162(m) proposed changes in the Senate Finance Committee Bill are substantially similar to the Section 162(m) changes in the House Bill. However, the Senate Finance Committee Bill differs from the House Bill in that the Senate Finance Committee Bill provides an exception for compensation payable pursuant to existing contracts that are not modified after November 2, 2017.

Equity Compensation

1. Are there any equity compensation changes in the Senate Finance Committee Bill?
   Yes, the Senate Finance Committee Bill adds a new Section 83(i) to the Code to provide a deferral feature for certain equity awards. Under Section 83(i), certain employees who are granted stock options or restricted stock units and who later receive stock upon exercise of the option or upon settlement of the restricted stock unit (“qualified stock”) may elect to defer the recognition of income for up to five years, if the corporation’s stock is not publicly traded and certain other requirements are met. A Section 83(i) deferral arrangement would not be treated as nonqualified deferred compensation under Section 409A of the Code solely because of the employee’s deferral election or the ability to make an election under Section 83(i).

   Our Comment: The Section 83(i) provisions in the Senate Finance Committee Bill are the same as the Section 83(i) provisions in the House Bill.

2. How about excise taxes on equity compensation?
   Currently, Section 4985 of the Code provides for a 15 percent excise tax on certain stock compensation held directly or indirectly by a disqualified person with respect to an expatriated corporation. For purposes of this tax, a “disqualified person” is any individual who during the 12-month period beginning on the date that is six months prior to the expatriation date is an officer, a director or a 10 percent-or-greater owner of the corporation. The Senate Finance Committee Bill would increase this excise tax to 20 percent. This change would apply to corporations that first become expatriated corporations after enactment of the Senate Finance Committee Bill.

Executive Compensation of Tax-Exempt Employers

Governmental 457(b) Changes

1. Are there any changes to the deferral limits for governmental 457(b) plans? 
   Under current law, the annual deferral limit for contributions to a governmental 457(b) plan is $18,500 for 2018. A separate $18,500 annual deferral limit applies for 2018 to employee contributions to a 403(b) plan or to a 401(k) plan (this limit is $24,500 if the employee is age 50 or older in 2018). The Senate Finance Committee Bill would change these limits by imposing one limit on employee deferrals to governmental 457(b) plans, 403(b) plans and 401(k) plans.

   Our Comment: This change would mean that for 2018, an executive who is eligible for a governmental employer’s 457(b) and 403(b) plans could contribute a maximum of $18,500 to both such plans (or $24,500 if the employee is age 50 or older), instead of contributing $18,500 (or $24,500 if age 50 or older) to the governmental 457(b) plan and $18,500 (or $24,500 if age 50 or older) to the 403(b) plan. This proposed change would not apply to non-governmental 457(b) plans.

2. What about special catch-up contributions to governmental 457(b) plans?
   Currently, special catch-up contributions may be made to governmental 457(b) plans in the last three taxable years ending before an employee reaches normal retirement age under the plan. The Senate Finance Committee Bill would eliminate these special catch-up contributions to governmental 457(b) plans.

3. When would these changes take effect?
   If the Senate Finance Committee Bill is enacted as currently drafted, the governmental 457(b) changes would apply to plan years and taxable years beginning after December 31, 2017.

Excise Tax on Executive Compensation

1. Is there a new excise tax on executive compensation paid by a tax-exempt employer?
   Similar to the House Bill, the Senate Finance Committee Bill provides for a 20 percent excise tax on certain executive compensation paid by an entity that is exempt from tax under Section 501(a) of the Code. The excise tax would equal 20 percent of the sum of (i) the compensation paid by the entity to any covered employee in excess of $1 million, plus (ii) the amount of any “excess parachute payment” paid by the entity to any covered employee. This tax would be imposed on the employer.

   A “covered employee” for purposes of this tax would include an employee who was among the organization’s five highest compensated employees in the current taxable year or who was a covered employee for any preceding taxable year beginning after December 31, 2016. The Senate Finance Committee Bill defines an “excess parachute payment” as an amount equal to the excess of any “parachute payment” over the employee’s “base amount” (the employee’s average annualized compensation from the employer over the five calendar years preceding his or her separation from service). An amount would be a parachute payment if it is contingent on the employee’s separation from employment and the present value of the compensation equals or exceeds three times the employee’s base amount. For purposes of this tax, “compensation” means an employee’s wages for federal income tax purposes under Section 3401(a) of the Code (but excludes designated Roth contributions).

   Our Comment: The tax-exempt employer executive compensation excise tax provisions are substantially similar in the Senate Finance Committee Bill and the House Bill. However, the Senate Finance Committee Bill clarifies that “compensation” includes amounts required to be included in gross income under Section 457(f) of the Code.

2. When would these changes take effect?
   If the Senate Finance Committee Bill is enacted as currently drafted, the new excise tax provisions would apply to taxable years beginning after December 31, 2017. 

Intermediate Sanction Rules

1. Does the Senate Finance Committee Bill subject tax-exempt organizations to potential excise taxes under the intermediate sanction rules?
   Currently, disqualified persons and organization managers who knowingly participate in the transaction may be subject to excise taxes under the intermediate sanction rules of Section 4958 of the Code in the event of an excess benefit transaction. The Senate Finance Committee Bill would also impose a 10 percent excise tax on the tax-exempt organization unless certain requirements are met. The 10 percent entity-level excise tax would not apply if the organization’s participation is not willful and is due to reasonable cause, and the organization follows minimum standards of due diligence or other procedures to ensure that no excess benefit is provided to a disqualified person. The organization would be treated as satisfying the minimum standards of due diligence if (i) the transaction was approved in advance by an authorized body of the organization composed entirely of individuals who did not have a conflict of interest, (ii) prior to approval of the transaction, the authorized body obtained and relied upon appropriate comparability data, and (iii) the authorized body adequately and concurrently documented the basis for approving the transaction.

2. Does the Senate Finance Committee Bill affect the rebuttable presumption of prudence under the intermediate sanction rules? 
   Under the Senate Finance Committee Bill, compliance with the minimum standards of due diligence or other procedures (as described in the previous answer) will not give rise to a rebuttable presumption of reasonableness for purposes of the intermediate sanction excise taxes and will not, by itself, support the conclusion that (i) an organizational manager did not act knowingly or (ii) the organization did not act willfully or without reasonable cause.

3. Does the Senate Finance Committee Bill affect the ability of an organization manager to rely on professional advice?
   Under the Senate Finance Committee Bill, an organization manager’s reliance on the written opinion of a professional advisor with respect to a transaction will not, by itself, preclude the manager from being treated as knowingly participating in the transaction.

4. Does the Senate Finance Committee Bill make any other changes to the intermediate sanction rules? 
   The Senate Finance Committee Bill expands the definition of “disqualified person” to include certain athletic coaches (and their family members) and additional types of investment advisors. The Senate Finance Committee Bill also extends the intermediate sanction rules to cover tax-exempt organizations described in Section 501(c)(5) of the Code (labor, agricultural or horticultural organizations) and Section 501(c)(6) of the Code (business leagues, chambers of commerce, etc.)

5. When would these changes take effect?
   If the Senate Finance Committee Bill is enacted as currently drafted, the changes to the intermediate sanction rules would apply to taxable years beginning after December 31, 2017.