Tax reform - Healthcare and employee benefit related changes
There are numerous changes that employers need to be aware of
TAX ALERT |
On Dec. 22, 2017, President Trump signed into law Congress’s tax reform legislation. The summary below addresses the changes that relate to compensation and employee benefits.
Individual shared responsibility - With respect to health care and employee benefits, the most important feature of the tax act is the elimination of the penalty on individual taxpayers who do not maintain minimum essential coverage. However, it is important to note that this elimination of the penalty is prospective and only applies for months beginning after Dec. 31, 2018. Thus, the penalty remains fully in effect for 2018.
With the reduction in the penalty, some employers may see fewer employees enroll in health care coverage during their 2019 healthcare benefit open enrollment period. However, most employees will continue to view employers that offer health insurance coverage more favorably than those who do not. Therefore, offering health insurance will remain a valuable and tax-efficient recruiting and retention tool.
This may also reduce the number of individuals who enroll in healthcare through either the federal or various state specific healthcare marketplaces. However, premium tax credits will still be available for those individuals that purchase health insurance through these marketplaces. If enough healthy individuals drop their coverage, both the individual and employer group health market will likely see some cost increases to pay for the adverse selection impact of this change.
It is also important to remember that this applies to the individual penalties only. The potential employer penalties for failing to offer coverage or offering inadequate coverage remain, as well as the current law’s information reporting requirement.
Roth recharacterization – Current law permits taxpayers to contribute, within limits, to both traditional and Roth individual retirement accounts (IRAs). A contribution to a traditional IRA may allow for a deduction of that contribution against gross income, while a person making a Roth IRA contribution gives up the current tax deduction in exchange for potentially tax-free growth of the account. Therefore, taxpayers must decide which IRA is the best for their circumstances. In addition, taxpayers have until the due date of their income tax return for the year of the contribution to change their minds and transfer their contribution (adjusted for earnings) from one type of IRA to another (a ‘recharacterization transaction’). One type of contribution is a Roth conversion contribution in which a taxpayer transfers money from an existing traditional IRA or employer retirement plan to a Roth IRA. Such a contribution is generally a taxable event. The Act, however, for taxable years beginning after Dec. 31, 2017, takes away the second look provision for Roth conversion contributions so once this conversion to a Roth takes place, there is no longer an opportunity to undo that conversion.
The second look provision remains in effect for non-conversion transactions. For example, a taxpayer may make a current year contribution to a Roth IRA and, before the due date for his or her income tax return for that year, recharacterize it as a contribution to a traditional IRA.
Workplace retirement plans - The Act makes numerous minor changes to workplace and other retirement plans. Specifically, as follows:
Extended rollover period – Normally, a participant in a retirement plan has 60 days to rollover a distribution from the plan to another retirement plan or IRA. Many qualified plans, as well as 403(b) and governmental 457(b) plans, offer employees the ability to borrow against their plan account. If an employee has an outstanding loan when he or she terminates employment or the plan terminates, the Code considers the loan to be a taxable distribution (an offset distribution) to the employee. That leaves the employee 60 days to find the money to roll the offset distribution amount into another retirement plan. Under the Act, in these situations, the employee will have until the extended due of his or her individual income tax return to rollover the deemed distribution. This extension does not apply to a deemed distribution that occurs when an active employee stops paying on a participant loan.
Disaster relief – The Act provided relief from the early withdrawal tax for ‘2016 disaster area’ distributions. Under the Act, an affected taxpayer is not subject to the penalty tax on the first $100,000 distributed from a qualified retirement plan, 403(b) plan, or IRA. In addition, the Act provided for an extended rollover period as well as a three-year ratable inclusion in income.
Public safety volunteers – The deferred compensation rules applicable to state and local governments as well as tax-exempt employers have a unique feature for such organizations that provide deferred compensation to non-employee volunteers (e.g., a volunteer firefighter). The benefit is in the form of a length of service award program under which a governmental or tax-exempt organization may award a volunteer up to $3,000 for every year of service. Congress set this $3,000 level in 1996, and now it has elected to raise the limit to $6,000, for tax years beginning after Dec. 31, 2017. Further, the annual limit will increase in $500 increments based on a cost of living adjustment.
Employee fringe benefits – From an employee perspective, there are several changes to existing fringe benefit rules.
- Reimbursing bicycle commuting expenses – Employers can no longer exclude as a nontaxable fringe benefit reimbursements to employees for qualified bicycle commuting expenses. This change is actually a suspension of the rule permitting the exclusion of up to $20 per month per employee. The rule reactivates on Jan. 1, 2026.
- Employee achievement awards – Under current law, certain employee achievement awards of tangible personal property are not, within limits, income to the employee. The act clarifies that items like cash, gift cards, other cash equivalents, theater or sporting tickets, vacation vouchers, etc. do not qualify as tangible personal property.
- Moving expense reimbursements – Current law excludes from an employee’s gross income any reimbursements received from an employer for moving expenses. The tax act suspends this exclusion tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026. The IRS clarified in Notice 2018-75 that the new rules do not apply to expenses incurred before Dec. 31, 2017 even if the reimbursement was received in 2018.
- Entertainment type expenses – The new tax law repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business (and the related rule applying a 50 percent limit to such deductions).
- Employee food and beverage expenses – Taxpayers will generally be able to continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel). In addition, for amounts incurred and paid after Dec. 31, 2017 and until Dec. 31, 2025, the provision expands this 50 percent limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer. Such amounts incurred and paid after Dec. 31, 2025 will not be deductible.
- Employee transportation expenses - Effective Jan. 1, 2018, section 274 was amended to limit or eliminate tax deductions for expenses related to qualified transportation fringe (QTF) benefits. The TCJA did not eliminate the tax-favored status of QTF benefits from employees or the ability to pay for the expenses with pretax dollars, only the employer’s deduction with respect to these expenses. Additionally, Congress amended section 512(a) to require a tax-exempt organization to pay unrelated business income tax (UBIT) to the extent the employer provides QTF benefits and a taxable employer would have a loss of deduction based on the same QTF benefits.
Family and medical leave credit – For 2018 and 2019, employers will be able to claim a general business credit for wages paid to qualifying employees during any period in which such employees are on family and medical leave. The amount of credit is 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave if the rate of payment under the program is 50 percent of the wages normally paid to an employee. The credit increases by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent. The maximum amount of family and medical leave that an employer may take into account with respect to any employee for any taxable year is 12 weeks.
Private Company Equity Grants – The law allows employees to elect delay for up to five years the taxation of compensation paid to certain employees of eligible corporations who receive compensation in the form of qualified stock. Qualified stock is stock that is not readily tradable on an established securities market and that is issued has a written plan in place to grant stock options or restricted stock units (RSUs) to at least 80 percent of all full-time, United States-based employees. Equity grants issued to certain excluded employees (i.e., CEO, CFO or a 1 percent owner, etc.) are not eligible for this election. This provision is in essence a private company substitute for the employee stock purchase plans that many public companies offer. See further details here.
Stock compensation of insiders in expatriated corporations – Specified holders (insiders) of stock options and other stock-based compensation are subject to an excise tax upon certain inversion transactions; the tax act increases the rate of tax from 15 percent to 20 percent.
Limitation on excessive employee compensation – Under section 162(m) of the current law, publicly traded corporations are not allowed to deduct more than $1 million in compensation annually that is paid to the covered employees (i.e. CEO and certain other highly paid officers), with a big exception for performance-based compensation. The Act repeals the performance-based compensation exception. There are other modifications to the definition of covered employees and expands what is considered an applicable employer. This provision is effective beginning with all taxable years after Dec. 31, 2017, except for written binding contracts if effect on Nov. 2, 2017, that have not been materially modified.
The IRS issued additional guidance in Notice 2018-68 to clarify some aspects of the new section 162(m) provisions. Additional guidance will still be essential to fully interpret the transition rule for written binding contracts already in existence. Until further guidance is issued, employers who are affected by section 162(m) will need to carefully examine existing contracts and modifications to understand whether the deduction for payments should be limited.
Excise tax on excess executive compensation paid by tax-exempt organizations – Similarly, with covered employees of publicly traded corporations the Act will begin imposing an excise tax on excess executive compensation paid by tax-exempt (and related) organizations for taxable years after Dec. 31, 2017. The excise tax imposed is the sum of (1) remuneration paid by an applicable tax-exempt organization to any covered employee in excess of $1 million, and (2) any excess parachute payments made to covered employees. The employer will be liable for an excise tax of 21 percent imposed on the excess. An applicable tax-exempt organization includes any organization exempt from tax under Section 501(a), as well as other types of tax-exempt entities defined in the Act. Further the Act defines a 'covered employee' as one of the five highly compensated employees of the organization for the taxable year, or any covered employee in a year after 2016.
Other benefit-related provisions that are NOT in the final act
Earlier legislative drafts by the House and Senate included proposals that would have affected other areas of employee compensation and benefits. These provisions were not included in the final Act so they remain the same as under current law:
- Employer-provided child care credit
- Work opportunity tax credit
- Medical savings accounts
- Dependent care assistance
- Hardship distributions from qualified plans
- Uniform in-service distribution rules for pension and employee savings plans
- Nondiscrimination rules for frozen defined benefit plans
- Employer social security taxes on employee tips
- Nonqualified deferred compensation taxed on vesting
- Employer-provided housing exclusion
- Employer-provided adoption credit
- Employer-provided education assistance
Income tax withholding
The act eliminated personal exemptions and increased the standard deductions for taxpayers to the following:
- $24,000 for married taxpayers filing jointly
- $18,000 for heads of households
- $12,000 for all other individuals
These changes mean that current IRS withholding tables (which use a person’s exemption and filing status as the basis for required income tax withholding) are completely out of date. Employers and payroll providers will be anxious for the IRS to issue revised guidelines.
As with all other areas, these compensation and benefit related changes require employers to reevaluate some policies. The good news is that the changes are not as monumental as the changes in many other areas. The bad news is that could lull employers into overlooking them. As always, tread lightly and consult your tax advisor as necessary.