The Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”) made some significant changes to the executive pay area for tax-exempt organizations with the imposition of a new excise tax on certain amounts paid to some employees of the tax-exempt organization. Imposing taxation in areas which previously had no such result will warrant tax-exempt organizations reviewing their compensation structures in light of the new rules to ensure not only an understanding of the new rules but to evaluate feasible options in minimizing any taxes.
President-elect Trump proposes to reduce the maximum corporate income tax rate from 35 percent to 15 percent. While the effective date of any rate reduction is uncertain, it likely will not occur before 2018. Deductions claimed when tax rates are 35 percent are worth 20 percent more to the taxpayer than if the same deduction is claimed when rates are 15 percent. Thus, a deduction for a $10 million pension contribution is worth an additional $2 million if claimed in 2017 when the tax rate is 35 percent than if claimed in 2018 when the tax rate is 15 percent.
This article, Accelerating Deductions for Compensation and Benefits if Corporate Tax Rates Are Reduced, discusses how bonus accruals, welfare benefits and pension contributions that might be deducted in 2017 rather than 2018 without much, if any, in the way of additional costs or administrative burdens for the employer and no adverse tax consequences for the employees/participants. Accelerating the deductions for these amounts will result in considerable savings if rates are reduced.
As employers have moved away from traditional defined benefit plans toward defined contribution plans as the primary retirement savings vehicle for their employees, much has been written about the risks of shifting the retirement savings burden from the employer to the employee. One widely-recognized consequence of this shift in retirement savings methods is that many employees are not contributing enough of their income, or earning high enough returns on their investments, to provide sufficient funds to meet their retirement needs through defined contribution plans. Many plan sponsors have responded to this concern by adding features to their defined contribution plans, such as automatic enrollment, automatic annual increases of employee deferral percentages and increased matching contributions, in order to encourage employees to save more for retirement.
Another consequence of this shift to defined contribution plans that has received less attention is that employees who suffer long-term disability are left without the retirement safety net that often has been provided under defined benefit plans. Employees typically lose the ability to continue making contributions to a defined contribution plan upon becoming disabled and often rely on their retirement savings under a defined contribution plan to meet their current income needs. While the Internal Revenue Code (the Code) and the regulations thereunder provide a framework for incorporating long-term disability benefits into defined contribution plans, these benefits have yet to become widely adopted by plan sponsors, perhaps partially due to inconsistent guidance from the Internal Revenue Service (the IRS) and uncertainly on the part of plan sponsors regarding how such benefits can be implemented in practice. However, as employers continue to limit, and in some cases terminate, defined benefit plans, it will become more pressing to turn these theoretical frameworks into workable solutions to provide an important benefit for disabled employees.
On May 18, 2014, the Internal Revenue Service (IRS) ruled that an employer’s wholly owned captive insurance subsidiary could reinsure the employer’s retiree medical benefit risks and still qualify as insurance for federal tax purposes, even though the retiree medical reinsurance policy was the only business of the captive. The IRS held that the insured risks were those of the retirees and their dependents, not of the employer or the employer’s voluntary employee benefit association that purchased the insurance policy reinsured through the captive. The ruling will serve as guidance for employers seeking to structure and implement similar captive reinsurance arrangements that are eligible for favorable federal tax treatment.
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