US Tax Reforms The English Translation
A Beginner’s Guide to Tax Changes in the US
The Tax Cuts and Jobs Act includes sweeping changes to the tax code in the US for individuals and businesses. Specific to our area of focus, it significantly affects a public company’s ability to deduct compensation paid to certain executives, among other changes that impact future executive pay.
- The major changes, as outlined by the Harvard Law School Forum on Corporate Governance and Financial Regulation, for tax years beginning on or after January 1, 2018 are:
- Repealing the exceptions for “performance-based compensation” under the 1986 IRS Code Section 162(m) so that all compensation over US$1 million per year is now non-deductible (for ‘covered employees’);
- Expanding the scope of ’covered’ to include CFO, for example;
- Expanding the scope of corporations to which Section 162(m) would apply to include those with publicly traded debt and foreign private issuers;
- Changes in individual tax rates and elimination of deductions for state and local income taxes; and
- Decreasing corporate tax rates from 35% to 21%.
While the new 162(m) laws will no longer serve as a tax incentive for companies to comply with rigorous technical requirements including shareholder approval of goals, U.S. public companies will nonetheless continue to offer executives performance-based incentive compensation. Indeed, shareholders and proxy advisory firms will continue to expect alignment of performance-based pay and plans that support long-term value creation. Interestingly, design and implementation will now be possible without regard to the highly technical and prescriptive requirements of Section 162(m).
- Performance-based pay can apply to any performance metrics deemed appropriate.
- The compensation committee can exercise discretion in either direction on any final pay-outs (previously, only negative discretion was allowed).
- Adjustments to performance goals need not be objective or determined in advance; depending on business circumstances, the compensation committee can adjust goals as needed.
- The preferential treatment of stock options and stock appreciation under Section 162(m) goes away, allowing for other performance-based compensation or award ‘currencies’.
- Equity plans can now be amended to remove complex provisions ensuring they qualify as performance-based, although shareholder approval of such amendments may still be required, of course.
US companies are likely now discussing:
- Updating equity plan prospectuses if they include tax disclosure regarding Section 162(m);
- Revisiting or discontinuing cash bonus plans with Section 162(m) provisions in favour of more flexible arrangements; and
- Reviewing who their covered employees will be for 2018 and beyond (likely ensuring the executive officer list is as narrow as possible)
What have U.S. companies done?
Pearl Meyer conducts Quick Polls, designed to provide up-to-date data and insights on trends. We conducted a poll of 300 clients in January this year, looking at the ways in which companies have or are considering responding to reduction of corporate tax rates to 21% under the Tax Cuts and Jobs Act. The following enhanced benefits are provided to employees:
- Roughly 20% of respondents have already provided some enhanced benefits to employees, and 35% are considering additional or new benefits;
- Current actions have most frequently consisted of one-time bonuses and increases in minimum wage—future considerations are more nuanced and reflect a longer-term enhancement to pay and benefits;
- The most common reasons for taking action or contemplating action included sharing the benefits of tax reform and recognising their employees’ efforts for the success of the business; and
- 88% of respondents who have made changes or are contemplating changes did not explicitly consider changes relative to a sharing ratio of any expected tax benefits with employees.
For those that have taken action, they made two changes to company programmes, on average.
- The most common action is a one-time bonus to employees, with over half of respondents providing a $1,000 bonus.
- 95% made structural changes to compensation—increasing the minimum wage and increasing salaries and retirement benefits.
Interestingly, 79% of respondents indicated that the board or compensation committee were involved in the decision-making process.