If the Tax Cuts and Jobs Act (the “Act”) is enacted, as currently drafted, then it would kill non-qualified deferred compensation as we know it today. The Act, which was introduced on November 3, 2017, proposes major changes to the taxation of deferred compensation. Some specific highlights are summarized below:
- Section 409A of the Internal Revenue Code of 1986, as amended, (the “Code”) would be eliminated.
- A new Code Section 409B would tax nonqualified deferred compensation as soon as it is no longer subject to a substantial risk of forfeiture (i.e., once it is no longer subject to the future performance of substantial services) instead of when it is distributed.
- Code Section 409B “nonqualified deferred compensation plans” will include stock options, stock appreciation rights (“SARs”), and other compensation rights that are based upon the value, or appreciation in value, of company stock. As such, stock options and SARs would be taxable on the date of grant because the Act does not exclude statutory stock options or non-qualified stock options that are granted with an exercise price equal to the fair market value of the underlying stock on the date of grant. This means stock options and SARs would be taxed at vesting.
- While the proposed new rules would not apply to deferred compensation attributable to services prior to January 1, 2018, such amounts would have to be included in income by the later of: (1) the last taxable year beginning before 2026; or (2) the taxable year in which there is no longer a substantial risk of forfeiture. In addition, the Act does not provide any type of “grandfathering” for arrangements that were in place prior to January 1, 2018.
- In addition to eliminating Code Section 409A, the Act would eliminate Code Sections 457A, 457(f), and 457(b), with respect to exempt organizations, for deferred compensation that is earned after December 31, 2017.
If Code Section 409B becomes law (without substantive changes, which are still being negotiated), employers would need to significantly change their incentive compensation structure. This is because many types of plans and arrangements that employers currently utilize would lose their tax incentives.