In case you missed it, according to this article in Bloomberg BNA, the new tax proposal would eliminate tax benefits under IRC Section 162(m), which allows companies to deduct executive compensation over $1 million (in addition to regularly deductible compensation up to $1 million) so long as it is performance-based and meets certain other conditions, such as shareholder approval and approval by a committee of “outside directors.” According to the article, the proposal would retain the $1 million cap on deductible compensation but eliminate the exemption for performance-based pay that exceeded the cap.
Section 162(m) was originally intended to curb executive compensation excesses, but hasn’t exactly lived up to those original expectations—critics maintain that it actually caused executive compensation to spiral even higher, as companies, seeking to qualify for the deduction, increased the level of performance-based pay, particularly through the use of equity. According to the article, instead of limiting compensation for executives, it “established a salary of at least $1 million as a benchmark for CEOs at major public companies, and prompted boards to make stock options and restricted shares key ingredients of executive pay. About 57 percent of S&P 500 chief executives have salaries of more than $1 million, according to data compiled by Bloomberg. Average reported compensation for CEOs in the index rose to $9.1 million from $3.7 million in the first decade after the law was passed, according to a 2005 Harvard Law School study. In 2016, the average had risen to $14.6 million, according to the Bloomberg Pay Index, which values compensation as of a company’s fiscal year-end, not the day it’s granted.”
The new tax proposal would also affect the use of non-qualified deferred comp plans, which allow executives to contribute compensation, over 401(k) limits, and permit it to grow tax deferred until they withdraw it years later. Under the new tax proposal, the article reports, contributions would be taxed “as soon as the money is at ‘no substantial risk of forfeiture,’ potentially meaning as soon as any vesting restrictions lapse. Salaries and bonuses that come without vesting hurdles will therefore get taxed right away,” thus eliminating much of the benefit of tax deferral. Under the proposal, the new rule would “apply to new amounts earned and deferred after 2017, while existing balances will be subject to the new rule by 2026.”
Of course, the new tax proposal could change significantly before adoption, assuming it’s adopted at all, that is.
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