Update on 162(m) and 4960
Beware of Hidden Taxes for Highly Paid Employees
The 2017 Tax Cuts and Jobs Act (TCJA) received clarifications over the summer and it’s a good time to assess your executives and possible other highly paid employees. The new rules create somewhat of a convergence between tax deduction rules at public held companies and nonprofit organizations. Regardless of which side of the line you’re on, $1,000,000 has become a pretty important number. This reminder is not intended as a comprehensive technical analysis. Our goal is to raise awareness and let companies know that they should be planning for the 2019 tax season before it’s too late. You may also want to speak with your outside counsel to get their take on this important issue.
Does anyone at your company make more than $1,000,000 in a given year?
Under the 2017 TCJA, 162(m) applies to publicly held companies and 4960 applies to nonprofit companies. Both rules provide for higher employer tax payments when certain individuals are paid more than one-million dollars, and sometimes when they are paid less.
If you are a nonprofit organization “anyone” really means anyone. The new rule 4960 applies to “covered employees” who are defined as the five highest paid employees at a company, whether or not these individuals serve as executives. For some organizations this may mean a doctor, fundraiser, or other key employee without executive responsibilities. Even more interesting? Once an individual is classified as a covered employee (for 2017 or later) they carry this classification forever. Yes, even when they are no longer anywhere near the top five paid employees.
It is important to note that the non-profit employer is responsible for paying taxes related to 4960 in excess of the $1 Million threshold. Additionally, an individual who is paid by multiple non-profits may need to have the excess proportionately distributed between the organizations. Lastly, 4960 applies if someone leaves with a “parachute payment” where the aggregate present value (not the amount immediately paid) is more than three times their base compensation. Unlike the “Golden Parachute” rules, this does not require triggering based on a change in control. Any termination will require this calculation.
For publicly held companies, the rule 162(m) is slightly less onerous. The new rule is still a big change from the past. “Covered Employees” are defined as the Principal Executive Officer (the PEO is usually the CEO), the Principal Financial Officer (the PFO is usually the CFO), and the remaining three highest compensation officers. But, there is a twist. Any who acted in the role of PEO or PFO is a covered employee, even if there were multiple people in the role throughout the year. And the next three highest paid executives includes anyone who was an executive at any point during the year. This may mean that people who held the role only temporarily may need to be included in reporting. And, like nonprofits, once you are a covered employee, you are always a covered employee. This will mean reporting for more than five individuals for many companies.
There are some grandfathering rules for legacy compensation plans, but those plans needed to be in place as of, and essentially remain unchanged since, November 2, 2017. There may be more wiggle room for CFOs who had employment agreements in place prior to the 2017 deadline. Since they did not fall under the required reporting rule in the past, their pay over $1 Million may still be deductible.
Yes. Someone at my company makes more than $1,000,000. What should I do?
1. You need to determine if there is anyone who could be impacted by these rules.
2. Non-profits need to identify their five highest paid individuals and review the programs that may trigger an unexpected individual getting added to the list. You also need to review anyone terminated in the past to determine if they need to be included in the calculations
3. Publicly traded companies need to review anyone who has held the position of PEO or PFO. You also need to identify the three highest paid current and former executives beyond the PEO and PFO. You should put together a database of anyone who is, or may someday be, impacted since this will now become an annual project.
4. Speak with your external counsel and tax advisors.
5. Contact FutureSense to get assistance with your executive compensation reviews, or in designing new pay programs that are better suited for these new rules.
6. Lastly, here is the link to a 22 page document from the IRS providing details on 162(m). https://www.irs.gov/pub/irs-drop/n-18-68.pdf
These changes to 162(m) and 4960 are the first material updates in a couple of decades. Most of the rules are fairly well defined, but the process and calculations are new. We are also confident that new strategies and planning opportunities will continue to emerge as companies and their advisors navigate this new ground. Subscribe to our mailing list for future updates.