This is the second in a series of articles by which the Spencer Fane LLP Employee Benefits Practice Team will explain key changes made in the employee benefits area by the Tax Cuts and Jobs Act (Public Law 115-97), which was signed into law on December 22, 2017. In addition to establishing new rules for transportation fringe benefits (see our first article in this series), the Act makes a number of changes that may affect how employers structure their executive compensation programs. This article describes the Act’s impact on for-profit employers, and outlines options that those employers should consider for their compensation arrangements.
A recent IRS Chief Counsel Memorandum (AM 2017-01) raises the stakes for employers that fail to apply the proper FICA taxation rules to nonqualified deferred compensation. An option previously available to those employers has been taken off the table. Under this option – which required a formal “Closing Agreement” with the IRS – both employer and employee FICA taxes could be minimized by voluntarily paying those taxes for years as to which IRS assessments were otherwise barred under the Tax Code’s three-year statute of limitations. Without this correction option, employers have an even greater incentive to apply the proper FICA taxation rules to their deferred compensation arrangements.
Although the compensation that an employer pays to an employee is generally subject to FICA taxation at the time the compensation is paid, there are special rules for the FICA tax treatment of amounts payable under nonqualified deferred compensation plans (such as long-term incentive plans or supplemental retirement programs). These rules affect both the timing, and the amount, of the FICA tax that is payable with respect to such compensation (which tax is typically shared 50/50 by the employer and employee). In the recent case of Davidson v. Henkel, an employer that failed to heed those special rules found itself facing the prospect of bearing substantial additional tax liability – for both the employer’s and the employee’s share of the FICA tax. This case serves as a reminder that employers should pay special attention to when amounts deferred under a nonqualified plan are properly taken into account as “wages” for purposes of FICA taxes.
Recent IRS guidance makes clear that deferred compensation arrangements under which payments are conditioned on the execution of a release of claims could pose a problem under Section 409A of the Internal Revenue Code. Fortunately, the IRS has also announced a voluntary correction program under which this Section 409A violation may be corrected. Employers wishing to take advantage of this correction program must act quickly, however, because this aspect of the program expires at the end of 2012.
Employers and their executives should note a year-end deadline for correcting certain failures to comply with the “documentation” requirements of Section 409A of the Internal Revenue Code. As explained in our March 2010 article, IRS Notice 2010-6 created a program for correcting such failures, but with many of its generous transitional rules expiring on December 31, 2010.
When corporate executives also serve as ERISA fiduciaries for employee stock ownership plans (“ESOPs”), their business decisions may become subject to heightened legal scrutiny. That was the holding of the Ninth U.S. Court of Appeals in a recent case in which ESOP participants raised ERISA challenges to a CEO’s compensation package. The decision also upheld a California federal trial court’s ruling that barred the executives from using corporate assets to pay their defense costs. (Johnson v. Couturier, 7/27/09). Although this decision is at odds with holdings from the Eighth U.S. Circuit Court of Appeals (whose jurisdiction includes Missouri), it may nonetheless give ESOP fiduciaries pause when making certain business decisions.
Since Congress enacted sweeping new legislation governing nonqualified deferred compensation arrangements two years ago (in the form of Tax Code Section 409A), the focus of the benefits community has been on how those arrangements are treated for tax purposes.
Final rules adopted by the Securities and Exchange Commission on July 26, 2006, will require companies with publicly-traded securities to significantly alter the way that they disclose their executive compensation practices in proxy and registration statements. These rules are generally designed to require the disclosure of all of the compensation that executives receive. They expand the list of executives for whom disclosures must be made, substantially modify the format and content of the required disclosures, and place heightened scrutiny on options-granting practices.