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Responding to “performance pay” rule changes

Responding to “performance pay” rule changes

Responding to “performance pay” rule changes

Responding to “performance pay” rule changes

The new tax law made some significant changes with respect to the rules regarding executive compensation paid by corporations, especially around “pay-for-performance” rewards. It’s unlikely that these changes will affect the total amounts paid to executives; however, they may cause companies to reconsider how they’re paying their executives.

Generally speaking, under the old law and prior to 2018, a public corporation could not deduct compensation in excess of USD1 million paid out to its CEO and three highest-paid employees. Performance bonuses, options, equity, deferred compensation, and similar pay-for-performance rewards were not included in this USD1 million limit and could be deducted. Under the new tax law, CFOs are included as part of this group of covered employees; so now it’s the CEO, CFO, and the three highest-paid employees. Another change: Once you’re considered a covered employee, you’re always a covered employee — even after retirement. So the USD1 million deduction limit will continue to apply.

How will this influence executive compensation? The positive news, at least from the executive’s standpoint, is that it probably will not have a major impact. The reality is that many companies are already paying out base salaries in excess of USD1 million for competitive reasons and the tax deductibility of such compensation is not viewed as a major factor in putting together pay packages. Also, shareholders and investor committees like the concept of pay-for-performance rewards, so they’re likely to continue regardless of their deductibility. What may change, however, is the way performance pay is structured. Since tax deductibility may no longer be a factor, companies may look to structure the payments as cash rewards or restricted stock rather than, for example, as stock options.

A number of CTOs have reported that their companies are also considering making changes to severance packages for retiring executives as a result of the tax law changes. As noted earlier, a covered employee remains a covered employee, even when retired. As a result, some CTOs are wondering whether it makes tax sense to spread lump-sum payments of more than USD1 million over several years via a supplemental employee retirement plan or annuity-type arrangements. The tax law provides that payments made under a “written, binding contract” executed on or before 2 November 2017, can still be grandfathered and deducted under the old rules; however, there’s a caveat to this exception. If a company has the right to raise or lower the amount of the payout, this discretion may result in the contract not being considered binding.

CTOs are hoping for some guidance or clarification on this matter. In its absence, many are taking a more conservative position. If the company can alter the amount of the performance pay, then it’s being made under a nonbinding contract and is, therefore, not grandfathered. If guidance comes out later that allows for their arrangement to qualify under the grandfather exception, the companies can reverse the tax treatment if it’s worth doing so.

Questions to consider

— Have you reviewed executive contracts executed on or before 2 November 2017, to determine if payments can be grandfathered?

— Are you looking into revising executive compensation plans with respect to pay-forperformance rewards?

— With the USD1 million deduction limit, does it make tax and business sense to spread executives’ lump-sum retirement payments over a longer period of time?