Proposed Tax Reform Bill Includes Momentous Changes to Executive Compensation Laws

by Wilson Sonsini Goodrich & Rosati
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The chairman of the U.S. House of Representatives' Committee on Ways and Means released a draft bill (the Tax Reform Act of 2014) on February 26, 2014, that would dramatically reform the Internal Revenue Code. Executive compensation laws are among the targets in the tax reform proposal. The proposal probably has little chance of becoming law in its current form, but it is significant because it likely will serve as a basis for future negotiations on tax reform and its executive compensation provisions may be seen again in future legislation.

Prohibition on Deferring Compensation After 2014 and Repeal of Section 409A

Currently, Internal Revenue Code Section 409A provides a complex regime that allows service providers to defer income tax on certain compensation until amounts are paid, even though the amounts already are vested. The proposed bill provides that after 2014, compensation for services will be taxed when amounts vest.1 This eliminates the opportunity to defer income tax on compensation until future years.2 The bill also would repeal Section 409A with respect to amounts attributable to services performed after 2014. Section 409A would continue to apply to deferred compensation related to services performed before 2015 and those prior deferrals would be includible in income generally in the later of (a) calendar year 2022 or (b) the year the amounts vest.

Changes to Section 162(m)

The proposed bill repeals two exceptions to the $1 million annual deduction limit for publicly traded companies under Internal Revenue Code Section 162(m) by subjecting both performance-based compensation (including stock options and stock appreciation rights) and commission pay to that limit. This would be a dramatic change for public companies that have structured their compensation programs for senior executives to minimize the impact of the deduction limit. The bill also would significantly expand the coverage of Section 162(m) by providing that if an individual is considered a covered employee in 2014 or later, he or she will continue to be a covered employee in future years. Under the bill, the Section 162(m) covered employees for any year easily could number greater than five and would include (a) all individuals serving as the company's chief executive officer at any time during the taxable year, regardless of compensation level; (b) all individuals serving as the company's chief financial officer at any time during the taxable year, regardless of compensation level; and (c) the three other highest-paid executive officers for the taxable year.

1 Compensation under a tax-qualified retirement plan, bona fide leave plan, disability, or death benefit plan generally would be exempt from these rules.

2 The proposed bill provides that compensation that is paid no later than six months after the end of the employer's tax year in which the compensation vests will not be considered deferred compensation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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