2019 year-end tax letter: employee benefits and executive compensation update

Authored by Christine Faris

Key takeaway: The TCJA and the potential SECURE Act, while advertising simplification and more taxpayer flexibility, further complicate the already complex world of employee benefits and executive compensation.

As we move into the final quarter of 2019, Congress has proposed landmark legislation that would have significant impact in the areas of employee benefits and executive compensation. The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 would expand opportunities to increase retirement savings by, for example, repealing the maximum age for IRA contributions, delaying the age for required minimum distributions to age 72, and requiring part-time employees to participate in their employer’s 401(k) plan. In addition, the Tax Cuts and Jobs Act enacted in December 2017 included many provisions that affect the tax treatment of executive compensation and employee benefits. With all of that said, the following topics of interest will be important for you to consider both for year-end tax planning and for 2020:

1. Health reimbursement arrangements (HRA): New HRA rules provide employers with additional flexibility in offering employee health coverage as well as more choice of coverage to employees without the previous requirement that the HRA be integrated with an employer-sponsored group health plan. This is accomplished by creating two new types of HRAs: individual coverage HRA and excepted benefit HRA. With an individual coverage HRA, HRA funds may be used to purchase individual health insurance coverage or Medicare. An employer may fund an excepted benefit HRA up to $1,800 per year to reimburse employees for excepted benefits such as dental and vision benefits.

2. Roth recharacterization: Converting a traditional IRA to a Roth IRA provides the taxpayer with the opportunity to hedge against future higher income tax rates. At the time of the conversion to the Roth IRA, the taxpayer pays income tax on the value of the account, and future increases in value would not be subject to income tax enabling the taxpayer to have tax-free withdrawals in retirement. A Roth recharacterization reverses the Roth IRA conversion. There are several reasons for doing this:

  • a.      The value of investments in the converted Roth IRA declined since the date of the conversion
  • b.      Higher-than-expected taxable income and/or the additional income from the Roth IRA conversion resulted in a bump to a higher federal income tax bracket
  • c.      Taxable income in retirement will likely be lower than expected, reducing the potential benefits of a Roth IRA’s tax-free distributions
  • d.      Not enough cash on hand to pay the taxes resulting from the conversion

    A taxpayer may still make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA, however, the taxpayer cannot later unwind the conversion through a recharacterization.

3. Employer Credit for Paid Family and Medical Leave: The TCJA created a new general business tax credit for employers that voluntarily offer up to 12 weeks of paid family and medical leave annually to qualifying employees. The amount of the tax credit is 12.5% if the leave benefit amount equals 50% of normal pay. The credit increases in 0.25% intervals, up to a maximum of 25%. The credit is a specified credit that may reduce the alternative minimum tax. It is available to employers regardless of their number of employees. To qualify for this temporary credit, the employer must have a written policy and provide at least two weeks’ annual paid family and medical leave at a minimum of 50% of the employee’s wages. Unless extended by Congress, it applies only with respect to wages for an eligible family and medical leave paid in taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2020.

4. Qualified transportation fringe benefits: Qualified transportation fringe benefits include qualified parking (parking on or near the employer’s business premises, or on or near a location from which the employee commutes to work by public transit) and the associated expenses, transit passes and vanpool benefits. A for-profit employer who offers its employees qualified transportation fringe benefits as pre-tax benefits is no longer allowed a corresponding tax deduction. A tax-exempt employer who offers these benefits may have a corresponding increase in its unrelated taxable income.

5. Bicycle commuting expenses: The TCJA also suspends the $20 per month employee tax exclusion for reimbursement of bicycle commuting expenses. Therefore, employer reimbursements for bicycle commuting expenses are taxable to the employee and subject to payroll and income tax withholding. This provision is effective for amounts paid or incurred between Jan. 1, 2018, and Dec. 31, 2025.

6. Executive compensation (for-profit companies): Effective Jan. 1, 2018, the TCJA expanded the scope of the $1 million executive compensation deduction limitation. In addition to publicly traded corporations, it now applies to nonpublic companies with publicly traded debt. The covered employee group was broadened to include the CEO and CFO and the three highest-paid officers (other than the CEO or CFO), and to eliminate the last-day-of-the-year requirement. Under the new rules, once a covered employee, always a covered employee regardless of employee status or death. The TCJA also eliminated the performance-based compensation exception to the $1 million deduction limitation. However, the changes to the performance-based exception will not apply to compensation payable under a written binding contract which was in effect on Nov. 2, 2017, provided the contract is not materially modified after that date.

7. Executive compensation (tax-exempt organizations): The TCJA added a new excise tax at the corporate tax rate of 21% on excess executive compensation by applicable tax-exempt organizations as well as nonpublic companies that have public debt. The tax is applicable to remuneration paid to a covered employee that exceeds $1 million in a tax year and excess parachute payments upon separation from employment. This new law is intended to put tax-exempt organizations in the same position as publicly held companies already subject to limits on the deductibility of high compensation amounts paid to certain executives. It also puts nonpublic companies that have public debt in an equivalent situation to that of public companies. The excise tax does not apply to remuneration made to licensed medical professionals (physicians, nurses and veterinarians), but only to the extent compensation payments relate directly to performance of medical services.

8. Student loan repayments: The Student Loan Repayment Acceleration Act was recently introduced in the Senate and would exclude employer contributions to student loan repayments of up to $10,000 from an employee’s gross income. Congress is also considering the Employer Participation in Repayment Act, which would expand the employer education assistance program by permitting employers to contribute up to $5,250 tax-free to an employee’s student loans.

In 2018, the IRS approved an employer’s proposal to offer a student loan repayment program as a component of its 401(k) plan. The ruling essentially allows employees to receive the equivalent of matching contributions without electing to make their own contributions. Although the ruling is binding only for the employer that sought the ruling, it does provide welcome guidance to employers seeking to provide employees with the opportunity to save for retirement on a tax-deferred basis while repaying their student loans. Employers who wish to add this feature may want to request their own private letter ruling from the IRS, especially if the design differs from the provisions approved in the ruling. In addition, employers that use a prototype or volume submitter plan document are limited by features that may be added and may have to change to an individually designed plan until the IRS issues regulatory guidance.

9. Expansion of multiple employer plans (MEPs): Treasury and the Department of Labor are working together to expand the use of MEPs, also known as association retirement plans. This would enable groups of smaller employers to band together to offer a retirement plan to their employees while sharing the cost and responsibility with other employers. The IRS recently issued proposed regulations that would allow the removal of a noncompliant employer without the risk of plan disqualification when one of the participating employers fails to follow the tax-qualification requirements.

10. Hardship withdrawals from retirement plans: Hardship withdrawals from 401(k) and 403(b) retirement plans no longer require the six-month prohibition on deferrals after a participant takes a hardship withdrawal. Also eliminated is the requirement that participants first take a loan from their plan account before taking a hardship withdrawal. These provisions could help an individual with a financial need continue saving for retirement without interruption as well as not having to forgo the employer matching contribution. These provisions are effective for plan years beginning on or after Jan. 1, 2019.

11. Distributions from retirement plans: A distribution from a qualified retirement plan, such as a 401(k), is taxable in the year of receipt, regardless of whether it is subsequently cashed in a later year or not cashed at all. The taxpayer’s failure to cash the distribution check has no effect on the plan administrator’s tax withholding obligation or liability for payment of that tax, nor does it alter the reporting obligation. The distribution, including the amount of the check and the amount withheld, must be reported on Form 1099-R for the year in which it was issued.

12. Rollover of retirement plan loans: Participants who have a loan outstanding at the time of plan termination or severance from employment have a longer time frame to pay the amount of an outstanding plan loan to another qualified plan or an IRA in order to accomplish a tax-free rollover of the loan amount. If the unpaid loan balance were not repaid, it would become a taxable distribution subject to the 10% additional income tax on early distributions, unless an exception applies.

13. Required minimum distributions (RMDs): Congress is considering increasing the mandatory age to begin required minimum to age 72 from age 70½.

14. FICA taxation rules for nonqualified deferred compensation: We are still seeing numerous instances where employers are not taking into account deferred compensation for FICA at the appropriate time. Pursuant to the FICA “special timing rule,” deferred compensation is required to be taken into account at the later of the time of the performance of services and at such time when there is no longer a “substantial risk of forfeiture” in entitlement to the benefit — this is usually at such time as the benefit becomes vested. This, of course, is in contrast to the Self-Employment Contributions Act (SECA) rules that generally require the deferred compensation to be taken into account upon actual or constructive receipt of the benefit. Employers should focus on making sure deferred compensation, even if not distributed, is taken into account correctly in accordance with the special timing rule in a setting that requires payment of FICA taxes.

15. Proposed regulations interpreting deferred compensation rules: In the summer of 2016, the Department of the Treasury issued proposed regulations interpreting the deferred compensation rules, which apply to tax-exempt organizations and governmental subdivisions. These proposed regulations primarily address issues attendant with the granting and administration of “ineligible plans of deferred compensation” and are slated to become effective until following such time that final regulations have been issued. As of the time of the preparation of this letter, we have seen no activity by the current administration that would suggest these regulations will be finalized anytime soon. Therefore, for the present, we are regarding these proposed regulations as an indication of the IRS’ interpretation of certain income tax issues attendant with the application of these rules and nothing more.

16. Employer-provided vehicles: The IRS issued proposed regulations aimed at assisting employers in determining the valuation of employer-provided vehicles. The proposed regulations incorporate a higher base value of $50,000 as the maximum value for use of the vehicle cents-per-mile and fleet-average valuation rules effective for the 2018 calendar year — a substantial increase from the prior limitations of $12,800 for the vehicle cents-per-mile valuation method and $16,500 for the fleet-average valuation method. This effectively increases the number of methods that can be used in calculating the noncash compensation attributable to the personal use of employer-provided vehicles. Regardless of the valuation method chosen by an employer, the only way to distinguish between employment-related business driving and personal driving is on the basis of mileage. As such, it is recommended employers require an employee maintain a contemporaneous record with detailed entries for employment-connected business usage of the auto (time, place, mileage, business purpose).

17. Retirement plans and related tax incentives, making sense of the alternatives: Forty-five years ago, Congress passed legislation making long-term savings a priority for individual taxpayers. Over the intervening years, legislation has been enacted to expand saving plans for retirement to include healthcare and education expenses, among others. The following table summarizes the available tax-deferred savings programs:

Available tax-deferred savings programs

The complexity of the current system is baffling to many taxpayers. Some savings accounts have caps on permissible savings, others have phase-out thresholds based on income levels and some seem to be duplicative. Additional changes to retirement savings plans may be forthcoming as Congress considers the aforementioned SECURE Act, which would repeal the maximum age for making tax-deductible contributions to IRAs and increase the beginning age for required minimum distributions to 72 from 70½, among many other changes. Stay tuned.

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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

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