November 13, 2017 Senate proposed tax reform bill would dramatically affect employers On November 9, 2017, the Senate Finance Committee released a detailed description of its forthcoming proposed tax reform bill. The committee is scheduled to begin markup of the proposal on Monday, November 13, 2017. As previously reported, on November 2, 2017, the House released its version of the proposed tax reform bill (the Tax Cuts and Jobs Act or H.R. 1), containing numerous fringe benefit provisions in the nature of eliminating the tax-free status, disallowing the business deduction, limiting the tax-free exclusion or modifying the plan operation rules. While the House has made some amendments to the bill since first released, most of these provisions remain. (See Tax Alert 2017-1846.) The Senate, like the House, calls for changes in many fringe benefits but to a lesser degree than the House. For instance, the Senate proposal would preserve the current taxable wage exclusions for adoption, dependent care and educational assistance and employee achievement awards. The Senate proposal also would be more favorable to employers in the area of business tax credits, retaining current law for the Work Opportunity Tax Credit and other income tax credits connected to the workplace and employment (e.g., the credit for a portion of employer Social Security tax on tips). Of significant note, the Senate proposal would include worker classification provisions from the New Economy Works to Guarantee Independence and Growth (NEW GIG) Act of 2017 introduced in July 2017 by Senator John Thune (R-S.D.). The proposed provisions would create a new safe harbor that treats individuals as independent contractors, rather than employees, including individuals working in the gig economy who meet the safe harbor requirements. Before any tax reform measures can take effect, the House and Senate must each pass their versions of the bill, negotiate an agreement on any differences (reconciliation) and the President must sign the final compromise bill into law. Here we explain the Senate provisions of interest to employers and the implications should they become law. See the attachment to this Alert for a side-by-side comparison of the House and Senate proposals as of November 9, 2017. 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, 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. 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 in excess of $1 million. Provision The current seven tax brackets would be retained but would be revised as 10%, 12%, 22.5%, 25%, 32.5%, 35% and 38.5%. The standard deduction would be increased to $24,000 for joint filers (and surviving spouses) and $12,000 for individual filers. The deduction for personal exemptions and the personal exemption phase-out would be repealed. Effective date January 1, 2018 Implications Because the supplemental flat rate of income tax withholding would be reduced to 22.5% for supplemental wages up to $1 million for the year, and to 38.5% for supplemental wages over $1 million, employers would realize a reduction in costs when they pay federal income tax on behalf of their employees (i.e., gross-up). Taxable wage exclusion for certain fringe benefits The Senate proposes to repeal the exclusion from taxable wages that currently applies to certain fringe benefits and, for some fringe benefits, would eliminate or further limit the ability of a business to deduct their cost. Bicycle commuting benefit Current law Under Section 132(f) and Section 132(f)(1)(D), an exclusion from wages for federal income tax (FIT), federal income tax withholding (FITW), Social Security/Medicare (FICA) and federal unemployment insurance (FUTA) purposes applies to qualified bicycle commuting expenses of up to $20 per month during which the employee regularly uses the bicycle for a substantial portion of travel between home and work. The exclusion does not apply in the same month the employee receives other transportation fringe benefits from the employer (i.e., van pool, transit pass, parking on the employer's premises). Provision The exclusion for qualified bicycle commuting benefits would be repealed. Effective date January 1, 2018 Implications Employers will need to determine if they would continue offering this benefit in light of the inclusion in taxable wages and, if they offer the benefit, if they will pay FICA and FIT (and state and local taxes if applicable) on behalf of employees (i.e., gross up). Moving expenses Current law Currently, 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 residence, 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 will 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. Business deduction for certain fringe benefits The Senate proposes to disallow or limit the business deduction for certain fringe benefits. Eating facilities Current law Under Section 119(a)(1), employers are allowed to deduct 100% of the expenses they incur in furnishing meals on the work premises to employees, their spouses and dependents, provided the meals are furnished for the convenience of the employer. The IRS has ruled that meals catered to employees do not meet this requirement, and as such, are subject to a 50% deduction limitation. (ILM 201151020.) Provision A 50% deduction limit would apply to meals furnished on the employer's premises for the convenience of the employer. Effective date January 1, 2018 Implications Businesses will need to determine the budgetary impact of the lower deduction limit and to what extent they might change how they operate their eating facilities to remedy that impact. Entertainment expenses Current law Under Section 274, 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. Effective date January 1, 2018 Implications A business will need to decide how this deduction disallowance might alter its current entertainment policies and under what circumstances the business may want to claim a business deduction by adding the reimbursement for entertainment-related expenses to employees' wages subject to FIT, FITW, FICA and FUTA. Transportation fringe benefits Current law Businesses are allowed to deduct all of the expenses they incur in providing transportation fringes under Section 132(f) for qualified van pools, qualified parking at or near the workplace and transit benefits to their employees. For 2018, the exclusion from taxable wages subject to FIT, FITW, FICA and FUTA is $255 per month for van pools/transit passes and $255 for parking. Provision No business deduction would be allowed for employer-provided transportation fringe benefits, except those expenses incurred as necessary for ensuring the safety of an employee. Presumably, the exclusion from taxable wages subject to FIT, FITW, FICA and FUTA would be retained. Effective date January 1, 2018 Implications Businesses will need to decide how this deduction disallowance might alter their current policies for incurring transportation fringe benefit expenses on behalf of their employees. Current policies that make a pretax contribution option available to employees for the payment of their transit benefits or parking appear to be unaffected. Qualified retirement plans Current law Employees 50 or older are allowed to make additional catch-up contributions (generally subject to an annual limit of $6,000 for 2017) to a Section 401(k), Section 403(b) or Section 457(b) plan. Provision The provision would modify the rules to prohibit eligible employees from making catch-up pretax contributions if the employee receives wages of $500,000 or more in the preceding year. The provision would apply the same employee contributions limit under a government Section 457(b) plan that applies under present law to elective deferrals to Section 401(k) or Section 403(b) plans. The current rule allowing employer contributions to Section 403(b) plans for five years after termination of employment would be repealed. The provision also would revise the limit on aggregate contributions to a qualified defined contribution plan so that a single overall limit applies with respect to contributions for any employee by the same employer. Effective date January 1, 2018 Implications Businesses will need to examine their current retirement plans to determine the changes required. Payroll systems also would require modification to reflect the adjusted annual limit on employee pretax contributions. Nonqualified deferred compensation Current law Generally, nonqualified deferred compensation is included in wages for FICA and FUTA purposes when there is no longer a substantial risk of forfeiture (at vest), but is generally not included in wages subject to FIT or FITW until the amount is paid or constructively received. Provision Nonqualified deferred compensation would be included in wages subject to FIT and FITW when the amount is no longer subject to a substantial risk of forfeiture. A substantial risk of forfeiture (i.e.,vesting) for purposes of this provision would be based only on the performance of future services; performance-based or non-compete vesting would not be applicable. The effect of the provision generally is that nonqualified deferred compensation amounts would be subject to FIT, FITW, FICA and FUTA at the same time The definition of nonqualified deferred compensation would be expanded to include stock options (other than Section 422 incentive stock options and Section 423 employee stock purchase plan stock options) and stock appreciation rights (SARs). Effective date January 1, 2018, for amounts earned after December 31, 2017. Amounts earned prior to 2018 must be includible in income on the later of the last day of the tax year prior to January 1, 2027, or the tax year in which the amount becomes vested. Worker classification Provision The Senate proposal would include proposed worker classification provisions from the New Economy Works to Guarantee Independence and Growth (NEW GIG) Act of 2017 introduced in July 2017 by Senator John Thune (R-S.D.). The proposed provisions would create a new safe harbor that treats individuals as independent contractors, rather than employees, including individuals working in the gig economy who meet the safe harbor requirements. Effective date The provisions would generally be effective for services performed after December 31, 2017, and amounts paid for such services after such date. However, a contract and a service recipient or payer would not be treated as failing to meet the requirements under the proposal with respect to compensation paid to a service provider before 180 days after the date of the law's enactment. Implications The safe harbor would apply for federal income and employment tax purposes; however, it would not necessarily be recognized under other federal laws (e.g., those enforced by the US Department of Labor) or by the states for a range of provisions, including unemployment and workers' compensation insurance and those laws that protect wages and employment. Executive compensation Executive compensation deduction limit Current law Currently, 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 Senate proposal would expand the $1 million deduction limit that applies to compensation paid to top executives of publicly traded companies by eliminating the performance-based compensation and commissions exceptions to Section 162(m) and expand the definition of covered employee to specifically include the chief financial officer (CFO). In addition, the provision would limit the ongoing deductibility of deferred compensation paid to individuals who previously held a covered employee position, even after they no longer hold that position. Thus, once an individual is named as a covered employee, the $1 million deduction limitation would apply to compensation paid to that individual at any point in the future, including after the cessation of services. The provision would expand the applicability of the deduction limitation to foreign companies that are publicly traded on an American Depositary Receipt. The definition of publicly-traded companies subject to the deduction limit may include certain additional corporations that are not publicly traded, such as large private C or S corporations. Effective date January 1, 2018 Employee unreimbursed business expenses Current law In general, under Section 62, if employees incur business expenses in connection with services provided to the employer and the employer does not reimburse for those expenses, they can claim a deduction on their federal income tax return, but only as an itemized deduction and only to the extent the expenses exceed 2% of gross income. Examples of unreimbursed business expenses subject to the 2% floor include business liability insurance premiums, licenses and regulatory fees, malpractice insurance premiums, repayment of wage overpayments subject to the claim-of-right doctrine, tools of the trade and work clothing and uniforms not street wearable. Provision All miscellaneous itemized deductions subject to the 2% floor would be repealed. Effective date January 1, 2018 Implications In the case of wage repayments subject to the claim-of-right doctrine, businesses should be aware that their employees could suffer a larger federal income tax impact for certain wage payment errors if repayment is not made until years following the pay error. Businesses that do not reimburse their employees for certain business expenses they incur should consider the financial impact to employees that will result from their loss of the itemized deduction. ———————————————
——————————————— EY Payroll News Flash (including side-by-side comparison of the House and Senate proposals as of November 9, 2017)
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