November 6, 2017 House proposed tax reform bill would dramatically affect employers On November 2, 2017, the House Ways and Committee released its proposed tax reform bill (the Tax Cuts and Jobs Act, H.R. 1, the House Bill) and a section-by-section summary. If enacted in its current state, the House Bill's impact on employers would be the most far reaching in decades. The House Bill would eliminate numerous tax-favored fringe benefits, repeal or modify various business expense provisions, change the tax rules governing qualified retirement plans and nonqualified deferred compensation plans, modify or eliminate most employer income tax credits, such as the Work Opportunity Tax Credit, and revise the rules governing the deduction of executive compensation. The House Bill must be passed by the House and Senate before becoming law, a process that could take several weeks or more, with changes very likely before final passage. Here we explain the provisions of interest to employers as proposed in the House Bill and the implications should they become law. Get an update on these tax reform proposals in our December 5 webcast. Register here. Change in federal income tax rates, brackets and allowances As proposed in the House Bill, the tax brackets would be reduced from the current seven, down to just five, personal allowances would be eliminated and the standard deduction would increase. (Section 1001, H.R. 1, section-by-section summary) Current law For 2017, there are seven regular individual income tax brackets of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. A standard deduction applies of $6,350 for single and married individuals filing separate returns, $9,350 for heads of households, and $12,700 for married individuals filing a joint return. Taxpayers also may deduct $4,050 for each personal exemption. Employers may use a flat income tax withholding rate of 25% for supplemental wages of up to $1 million for the tax year and a rate of 39.6% is mandatory on supplemental wages over $1 million. Provision Five tax brackets would apply of 12%, 25%, 35%, and 39.6% and an effective fifth bracket at 0% in the form of the enhanced standard deduction. The standard deduction would be increased to $24,000 for joint filers (and surviving spouses) and $12,000 for individual filers. Single filers with at least one qualifying child could claim a standard deduction of $18,000. These amounts would be adjusted for inflation based on a chained consumer price index (CPI). For example, the standard deduction for joint filers would be $24,400 in 2018. The deduction for personal exemptions and the personal exemption phase-out would be repealed. Effective date January 1, 2018 Implications Employers that pay federal income tax on behalf of their employees (i.e., gross-up) could realize a reduction in expense in some cases in which the supplemental withholding rates are not used. Since the highest tax rate would remain at 39.6%, there is no change expected in the mandatory flat tax rate that applies to supplemental wages over $1 million. However, conforming legislation to modify Treas. Reg. Section 31.3402(g)-1 would be needed to confirm if the flat tax rate of 25% would continue to apply to supplemental wages up to $1 million in the year. Fringe benefits The House Bill proposes to repeal the exclusion from taxable wages that currently applies to certain fringe benefits, and would eliminate, for some fringe benefits, the ability of the business to deduct their cost. Conforming provisions would apply to non-profit organizations so that the impact of the fringe benefit deduction rules similarly apply to them. Adoption assistance (Section 1406, H.R. 1, section-by-section summary) Current law For 2017, Section 137 allows an exclusion from federal income tax (FIT) and federal income tax withholding (FITW) up to $13,570 for adoption assistance provided by the employer for each qualified adoption. The benefit is subject to Social Security/Medicare (FICA) and federal unemployment insurance (FUTA) tax. Adoption assistance may be included in a Section 125 cafeteria plan allowing employees to pay for their qualified adoption costs with pretax contributions. Provision The provision for the exclusion of employer-provided adoption assistance would be repealed. Effective date January 1, 2018 Implications Employees taking advantage of the pretax contribution option would no longer have the immediate benefit of the income tax deduction through the income tax withholding calculation. Employers that pay their employees' adoption expenses would need to consider how this benefit offering may change in light of the repeal of Section 137. Dependent care assistance (Section 1404, H.R. 1, section-by-section summary) Current law Section 129 allows an exclusion from taxable wages for FIT, FITW, FICA and FUTA purposes for employer-provided dependent care assistance benefits of up to $5,000 per year ($2,500 for married filing separately). Dependent care assistance may be included in an IRC Section 125 cafeteria plan allowing employees to pay for their qualified dependent care costs with pretax contributions. Provision The provision for the exclusion of employer-provided dependent care assistance would be repealed. Effective date January 1, 2018 Implications Employees taking advantage of the pretax contribution option (i.e., dependent care assistance flexible spending account (FSA)) would no longer realize a reduction in their FICA taxes for contributions they make to their dependent care FSAs nor would they get the immediate benefit of the income tax deduction through the income tax withholding calculation. Businesses offering dependent care assistance FSAs may realize an increase in their FICA tax expenses because there would no longer be a reduction in FICA wages for pretax contributions. Employers that pay their employees' dependent care costs would need to consider how this benefit offering may change in light of the repeal of Section 129. Finally, when considering a potential gross-up policy, keep in mind that expanded childcare tax credits are also proposed for individual taxpayers, which would offset income tax they incur on the employer-provided dependent care benefit. Educational assistance (Section 1204, H.R. 1, section-by-section summary) Current law Section 127 allows an exclusion from wages for FIT, FITW, FICA and FUTA purposes of up to $5,250 of graduate and undergraduate education costs that are not related to the employee's current job. As a working condition fringe benefit, work-related education is 100% excluded from wages subject to FIT, FITW, FICA and FUTA under Section 132(a)(3). Provision The exclusion for employer-provided educational assistance under Section127 would be repealed but the 100% exclusion for work-related education would remain. Effective date January 1, 2018 Implications Employers would need to consider if they will retain their current educational assistance plans, and if so, the extent to which they will pay FICA (and income tax) on behalf of their employees. When determining a gross-up policy for income tax, keep in mind that expanded education tax credits are also proposed for individual taxpayers that may offset income tax incurred on the employer-provided education benefit. Employee achievement awards (Section 1403, H.R. 1, section-by-section summary) Current law Sections 74(c) and 274(j) provide an exclusion from wages for FIT, FITW, FICA and FUTA purposes for employer-provided length of service and safety achievement awards. The exclusion is limited to $400 per employee per year if there is no qualified plan, and up to $1,600 under a qualified plan, with the average not exceeding $400 per employee. Other limitations apply, for instance, a length of service award is excluded from taxable wages only once every five years. Provision The provision for the exclusion of employee achievement awards would be repealed but the limit on the amount of such awards the employer could deduct for federal income tax purposes would be removed. Effective date January 1, 2018 Implications Employers would need to consider if they will pay employees' FITW and FICA on these awards, and if so, the budgetary impact of the added gross-up expense. Employers should also consider if the removal of the business deduction cap might increase the maximum value of awards they choose to offer in the future. Employer-provided housing (Section 1401, H.R. 1, section-by-section summary) Current law Section 119 provides an exclusion from wages for FIT, FITW, FICA and FUTA purposes for employer-provided housing furnished for the convenience of the employer if the employee is required to accept lodging on the premises of the employer as a condition of employment In the case of educational institutions, the value of housing provided to employees also is excluded to the extent that the rent paid by the employee is at least the lesser of 5% of the lodging's appraised value or the average of the rent paid by individuals (other than employees or students of the educational institution) for comparable lodging provided by the educational institution Provision The exclusion for housing provided for the convenience of the employer and for employees of educational institutions would be limited to $50,000 ($25,000 for a married individual filing a separate return) and would phase out for highly compensated individuals (income of $120,000 for 2017, as adjusted for inflation) at a rate of one dollar for every two dollars of adjusted gross income earned by the individual beyond the statutory threshold of being highly compensated. The exclusion would apply to only one residence per employee. Effective date January 1, 2018 Implications Employers would need to consider the overall budgetary impact of their housing costs should they decide to incur gross-up expenses for housing values exceeding the annual limit. Policy decisions would also be necessary for those employers that provide more than one residence to an employee. Medical savings account (Section 1311, H.R. 1, section-by-section summary) Current law Section 220 allows an individual to claim an above-the-line deduction for contributions to an Archer medical savings account (MSA). Employer contributions to the MSA are excluded from wages subject to FIT, FITW, FICA and FUTA. New MSA accounts cannot be established after 2005. MSA balances may be rolled over to a health savings account (HSA). Provision No deduction would be allowed for contributions to an MSA and employer contributions to an MSA would not be excluded from income. Existing MSA balances could continue to be rolled over on a tax-free basis to an HSA. Effective date January 1, 2018 Implications Employers currently maintaining MSAs would need to consider implementing an alternate medical spending account option, taking into account the health insurance plans offered to employees and the restrictions that apply to the various medical spending account options (i.e., HSA, health FSA or health reimbursement arrangement (HRA)). Moving expenses (Section 1405, H.R. 1, section-by-section summary) Current law Section 132(g) allows an exclusion from wages for FIT, FITW, FICA and FUTA purposes for moving expenses reimbursed by the employer to the extent those moving expenses are deductible under Section 217. Specifically, the exclusion applies to the cost of moving household goods and personal effects from the former residence to the new, the first 30 days of storage for a domestic move and travel expenses (excluding meals) incurred during the period of travel from the former residence to the new place of residence. Provision The exclusion for employer-reimbursed moving expenses would be repealed. Effective date January 1, 2018 Implications Most businesses would likely choose not to pass the FICA (or income tax) tax burden for these reimbursements to their employees. Consequently, where gross-ups will apply, businesses would face a higher cost for moving their employees. No business deduction for certain benefits exempt under Section 132 The House Bill proposes to disallow a business deduction for certain fringe benefits excluded from wages subject to FIT, on the basis that employees are not paying individual income tax on those benefits. The House Bill narrowly applies this provision to benefits excluded from taxable wages under Section 132 that are "primarily personal" in nature, namely, athletic facilities, transportation fringe benefits or amenities that involve property or services not directly related to the employer's trade or business, except to the extent that such benefits are included in wages subject to FIT (and FITW), Tax-exempt organizations So that private employers are not at a disadvantage, the House Bill also proposes taxing tax-exempt entities on the value of transportation fringe benefits, on-premises gyms and other athletic facilities, by treating the funds used to pay for such benefits as unrelated business taxable income. In so doing, the value of these employee benefits would be subject to a tax equal to the corporate federal income tax rate. (Sections 3307 and 3308, H.R. 1, section-by-section summary) Effective date January 1, 2018 Implications If this provision is enacted, private businesses would face the challenging and time-consuming burden of modifying accounting systems to account for items of compensation that are not taken into account when calculating their federal income tax obligations. For tax-exempt organizations, the impact could be more substantial because they must report the value of these benefits as unrelated taxable business income. Qualified retirement plans A number of changes are proposed to simplify the operation of qualified retirement plans and to give older workers an incentive to remain in the workforce. Age for allowabl>e in-service distributions (Section 1502, H.R. 1, section-by-section summary) Current law Defined contribution plans generally are not permitted to allow in-service distributions (i.e., distributions while an employee is still working for the employer) attributable to tax-deferred contributions if the employee is less than 59½. For state and local government defined contribution plans, and for all defined benefit plans, the restriction on in-service distributions applies if the employee is less than 62. Provision All defined benefit plans, as well as state and local government defined contribution plans, would be permitted to make in-service distributions for employees 59½ and older. Effective date January 1, 2018 Hardship distributions (Section 1503, H.R. 1, section-by-section summary) Current law Defined contribution plans are generally not permitted to allow in-service distributions (distributions while an employee is still working for the employer) attributable to elective deferrals if the employee is less than 59½. One exception is for hardship distributions, which plans may offer participants only if the plan follows guidelines, such as requiring an immediate and heavy financial need of the employee for any distribution to be made. Plans cannot allow employees taking hardship distributions to make contributions to the plan for six months after the distribution. Provision The IRS would be required within one year of the date of the law's enactment to change its guidance to allow employees taking hardship distributions to continue making contributions to the plan. Effective date Regulations would be effective for plan years beginning after December 31, 2017. Hardship withdrawals (Section 1504, H.R. 1, section-by-section summary) Current law Defined contribution plans are generally not permitted to allow in-service distributions (distributions while an employee is still working for the employer) attributable to elective deferrals if the employee is younger than 59½. One exception is for hardship distributions, which plans have the option of offering to participants. Hardship distributions may be allowed only for amounts actually contributed by the employee and may not include account earnings or amounts contributed by the employer. Provision Employers could choose to allow hardship distributions that include account earnings and employer contributions. Effective date January 1, 2018 Plan loan offset (Section 1505, H.R. 1, section-by-section summary) Current law Defined contribution plans are permitted (but not required) to allow plan loans. If the employee fails to abide by the applicable rules, the loan is treated as a taxable distribution that may also be subject to the 10% penalty for early withdrawals. If a plan terminates or an employee's employment terminates while a plan loan is outstanding, the employee has 60 days to contribute the loan balance to an individual retirement account (IRA), or the loan is treated as a distribution. Provision Employees whose plan terminates or who separate from employment while they have plan loans outstanding would have until the due date for filing their federal income tax return for that year to contribute the loan balance to an IRA to prevent the loan from being taxed as a distribution. Effective date January 1, 2018 Nondiscrimination rules (Section 1506, H.R. 1, section-by-section summary) Current law Employer-sponsored retirement plans must meet a variety of requirements to be tax-qualified, including nondiscrimination rules designed to confirm that the group of employees covered by a plan and the contribution or benefits provided to employees does not discriminate in favor of highly compensated employees. In general, employers may choose to stop allowing employees to accrue new benefits in a plan or only allow existing employees to accrue new benefits while closing the plan to new employees. For employers sponsoring both a defined contribution plan and a defined benefit plan, the nondiscrimination rules allow limited cross-testing between the two plans. However, some employers that allow current workers to continue to accrue benefits have closed their defined benefit plan to new employees out of concern for violating the nondiscrimination rules. Provision Expanded cross-testing between an employer's defined benefit and defined contribution plans would be allowed for purposes of nondiscrimination testing. Effective date The provision would be effective on the date of the law's enactment. Nonqualified deferred compensation The House Bill proposes to reduce complexity in the taxation and reporting of nonqualified deferred compensation by eliminating the timing difference for FIT and FICA obligations. This timing difference creates issues in the Social Security Administration's computation of benefits, complicates Form W-2 reporting, adds to the risk of employer penalty exposure, and recently (Davidson v. Henkel Corporation, DC MI, 115 AFTR 2d 2015-369, 1/6/15), has led to costly litigation for employers. (Section 3801, H.R. 1, section-by-section summary) Current law Generally, nonqualified deferred compensation is subject to FICA and FUTA when the risk of substantial forfeiture lapses (i.e., vests), but FIT or FITW apply at the time of distribution. Provision Nonqualified deferred compensation would be subject to FIT, FITW, FICA and FUTA at the time there is no longer a substantial risk of forfeiture (i.e., vesting). A condition shall not be treated as constituting a substantial risk of forfeiture solely because it consists of a covenant not to compete or because the condition relates (nominally or otherwise) to a purpose of the compensation other than the future performance of services, regardless of whether such condition is intended to advance a purpose of the compensation or is solely intended to defer taxation of the compensation. Effective date The provision would be effective for amounts attributable to services performed after December 31, 2017, except that the current law would continue to apply to existing nonqualified deferred compensation arrangements until the last tax year beginning before 2026, when such arrangements would become subject to this provision. Business expenses In addition to the disallowance of a deduction for certain exempt fringe benefits (see fringe benefits), the House also proposes to modify a number of other business expense deduction rules that are connected with the workforce. Entertainment expenses (Section 3307, H.R. 1, section-by-section summary) Current law A business can deduct up to 50% of expenses relating to entertainment, amusement or recreation activities, or facilities (including membership dues with respect to such activities or facilities) if directly related to the active conduct of the taxpayer's trade or business. An item is considered directly related if it is associated with a substantial and bona fide business discussion. Provision No deduction would be allowed for entertainment, amusement or recreation activities, facilities, or membership dues relating to such activities or other social purposes. The 50% limitation under current law also would apply only to expenses for food or beverages and to qualifying business meals under the provision, with no deduction allowed for other entertainment expenses. Additionally, no deduction would be allowed for reimbursed entertainment expenses paid as part of an expense reimbursement arrangement that involves a tax-indifferent party, such as a foreign person or an entity exempt from tax. Effective date January 1, 2018 Implications If the entertainment involves only employees, those expenses could be deducted as a working condition fringe benefit subject to limitations of Section 132. Executive compensation deduction limit (Section 3802, H.R. 1, section-by-section summary) Current law Under Section 162(m), a corporation generally may deduct compensation expenses of a covered employee of a publicly traded corporation of no more than $1 million per year. The deduction limitation applies to all remuneration paid to a covered employee for services, including cash and the cash value of all remuneration (including benefits) paid in a medium other than cash, subject to several significant exceptions: (1) commissions; (2) performance-based remuneration, including stock options; (3) payments to a tax-qualified retirement plan; and (4) amounts that are excludable from the executive's gross income. For these purposes, a covered employee is the chief executive officer (CEO) and the next four highest compensated officers based on the Securities and Exchange Commission (SEC) disclosure rules. Due to changes in the applicable SEC disclosure rules, IRS guidance has interpreted "covered employee" to mean the principal executive officer and the three highest compensated officers as of the close of the tax year. Provision The exceptions to the $1 million deduction limitation for commissions and performance-based compensation would be repealed. The provision also would revise the definition of "covered employee" to include the CEO, the chief financial officer, and the three other highest paid employees, realigning the definition with current SEC disclosure rules. Under the modified definition, once an employee qualifies as a covered person, the deduction limitation would apply for federal tax purposes to that person so long as the corporation pays remuneration to such person (or to any beneficiaries). Exempt organizations A tax-exempt organization would be subject to a 20% excise tax on compensation in excess of $1 million paid to any of its five highest paid employees for the tax year. The excise tax would apply to all remuneration paid to a covered person for services, including cash and the cash value of all remuneration (including benefits) paid in a medium other than cash, except for payments to a tax-qualified retirement plan, and amounts that are excludable from the executive's gross income. Once an employee qualifies as a covered person, the excise tax would apply to compensation in excess of $1 million paid to that person so long as the organization pays him remuneration. The excise tax also would apply to excess parachute payments paid by the organization to such individuals. Under the provision, an excess parachute payment generally would be a payment contingent on the employee's separation from employment with an aggregate present value of three times the employee's base compensation or more. Effective date January 1, 2018 Charitable mileage rate (Section 3306, H.R. 1, section-by-section summary) Current law The federal per-mile rate to calculate the deduction allowed for mileage incurred in connection with a charitable activity is fixed at $0.14. Provision The mileage rate for charitable service would be subject to adjustment annually for inflation. Effective date January 1, 2018 Employer income tax credits Current law includes a number of employer incentives in the nature of a credit against federal income tax, the most well-known being the Work Opportunity Tax Credit. To raise revenue, the House proposes to modify or repeal most of these credits. Work Opportunity Tax Credit (WOTC) (Section 3404, H.R. 1, section-by-section summary) Current law An employer may claim a federal income tax credit equal to 40% of qualified first-year wages for employees belonging to nine at-risk targeted groups. Such qualified wages are subject to various limits between $6,000 and $24,000, varying by the specific targeted group. This tax credit program was reinstated in 2015 under the PATH Act and is currently set to expire December 31, 2019. Provision The WOTC would be repealed. Effective date The provision would be effective for wages paid or incurred to individuals who begin work after December 31, 2017. Employer-provided childcare credit (Section 3402, H.R. 1, section-by-section summary) Current law An employer may claim a federal income tax credit equal to 25% of qualified expenses for employee child care and 10% of qualified expenses for child-care resource and referral services. The credit is limited to $150,000 per tax year. Provision The childcare credit would be repealed. Effective date January 1, 2018 Credit for portion of employer Social Security tax on tips (Section 3408, H.R. 1, section-by-section summary) Current law An employer may claim a federal income tax credit equal to its share of FICA taxes attributable to tips received from customers in connection with the provision of food or beverages, provided tipping is customary for that employer's customers. The credit is available only to the extent such tips exceed the amount of tips that the employer uses to meet the minimum wage requirements for the employee under the Fair Labor Standards Act, as it was on January 1, 2007 — $5.15 per hour. An employer may not claim a deduction for any amount taken into account in determining the credit. Provision The credit would be modified to reflect the current minimum wage so that it is available with regard to tips reported only above the current minimum wage rather than tips above $5.15 per hour. Additionally, all restaurants claiming the credit would be required to report to the IRS tip allocations among tipped employees (allocations at no less than 10% of gross receipts per tipped employee rather than 8%), which is a reporting requirement now required only of restaurants with at least 10 employees. Effective date Effective for tips received for services performed after December 31, 2017. Credit for providing access to disabled individuals (Section 3407, H.R. 1, section-by-section summary) Current law Small businesses may claim a 50% federal income credit per year for expenditures of between $250 and $10,250 for providing access to disabled individuals. A small business for this purpose is defined as a business with no more than $1 million in gross receipts or employing no more than 30 full-time employees. Provision The credit for providing access to disabled individuals would be repealed. Effective date January 1, 2018 ———————————————
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