The Tax Cuts and Jobs Act (the “Act”) recently enacted by Congress will soon become effective. The primary focus of the new law is the reduction of corporate and individual income taxes. Nevertheless, a number of provisions of the Act affect employee benefit programs, which are summarized below. Except as otherwise noted, these employee benefit changes are effective for plan or tax years, as applicable, beginning on or after January 1, 2018.
Repeal of ACA Individual Responsibility Penalty
Under the individual responsibility “play-or-pay” rules of the Affordable Care Act (“ACA”), individuals must obtain minimum essential health coverage if they can afford to do so. If an individual can afford health insurance but chooses not to buy it, the individual is subject to a penalty tax. The penalty currently is the greater of 2.5% of household income or $695 per adult ($347.50 per child under 18).
To provide individuals with evidence of this insurance coverage, insurance companies must provide a Form 1095-B to covered individuals. Employers that maintain self-insured medical plans will provide a Form 1095-C to covered employees.
Large employers (those with more than 50 full-time equivalent employees) are subject to a separate employer responsibility mandate obligating them to provide qualified coverage to full-time employees. The failure to provide the coverage exposes them to an excise tax penalty. Large employers must also file with the IRS a Form 1095-C for each full-time employee reporting as to the coverage provided (or not provided as the case may be) to the individual. A copy of the Form 1095-C was then also be provided to each full-time employee.
The provision of the ACA requiring individuals to have qualified insurance coverage, or to pay a penalty for the failure to do so, has effectively been eliminated, beginning in 2019. It will remain in effect for 2018. The elimination is made via the reduction of the penalty to $0. The separate employer responsibility coverage mandate penalty was not similarly eliminated.
The effective repeal of the individual responsibility penalty does not have a direct effect on an employer. However, for the 2019 plan year and beyond, large employers presumably will not be required to file and provide to employees Form 1095-Cs to its employees, evidencing their coverage under the plan (since the information is not required by the individuals for purposes of completing their tax returns). A large employer will nevertheless still be required to file with the IRS an abbreviated version of the Form 1095-Cs evidencing the offering of coverage to full-time employees, because the employer responsibility mandate is still effective.
Business Tax Credit for Paid Family or Medical Leave
For 2018 and 2019, eligible employers will be allowed to claim a general business tax credit equal to 12.5% of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave. To qualify for the business tax credit, the rate of paid leave must be at least 50% of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of paid leave exceeds 50%.
The maximum amount of family and medical leave that may be taken into account with respect to any employee for any taxable year is 12 weeks. To qualify for the credit, an employer must have a written policy that allows all qualifying full-time employees not less than two weeks of annual paid family and medical leave. The policy must also allow qualifying part-time employees a commensurate amount of leave on a pro rata basis.
A “qualifying employee” means any employee who has been employed by the employer for one year or more, and who for the preceding year, had compensation not in excess of 60% of the compensation threshold for highly compensated employees (which for 2018 means not in excess of $72,000).
“Family and medical leave” is defined as leave described under the federal Family and Medical Leave Act (FMLA). If an employer provides paid leave as vacation leave, personal leave, or other medical or sick leave, this paid leave will not be considered to be family and medical leave that is eligible for the business.
Qualified Stock Grants for Private Employers
Special tax rules apply to property, including employer stock, transferred to an employee in connection with the performance of services. Under these rules, an employee generally must recognize income in the taxable year in which the employee’s right to the stock is transferable or is not subject to a substantial risk of forfeiture, whichever occurs earlier (referred to herein as “substantially vested”). Thus, if the employee’s right to the stock is substantially vested when the stock is transferred to the employee, the employee recognizes income in the taxable year of such transfer, in an amount equal to the fair market value of the stock as of the date of transfer (less any amount paid for the stock). If at the time the stock is transferred to the employee, the employee’s right to the stock is not substantially vested, the employee does not recognize income attributable to the stock transfer until the taxable year in which the employee’s right becomes substantially vested. In this case, the amount includible in the employee’s income is the fair market value of the stock as of the date that the employee’s right to the stock is substantially vested (less any amount paid for the stock). The deferral elections must be made no later than 30 days after the stock becomes vested.
The Act allows private companies (i.e., those who do not have stock tradable on an established securities market) to establish a plan offering employees the right to elect to defer the recognition of income company stock acquired upon the exercise of stock options or the settlement of restricted stock units for up to five years. The deferral election must be made no later than 30 days after the stock becomes vested.
A key condition of the new provision is that the company must have a written plan under which at least 80% of all employees providing services to the company in the United States are granted qualified stock. Because of this rule, it is expected that the plans will more typically be adopted by start-up companies.
Extension of Plan Loan Offset Rollover Deadline
Qualified retirement plans, including 401(k) plans, often allow for loans to be made to participants. In turn, the loan policies for such plans typically provide that a participant’s outstanding loan becomes due and payable upon the participant’s termination of employment or the termination of the plan. If, in such a situation, the participant does not fully repay the outstanding loan within the time allowed by the plan, the loan balance (referred to as a loan offset) is treated as an actual taxable distribution from the plan (referred to as a loan offset). The participant if, under age 59½, will then also be subject to the 10% additional income tax on early distributions (unless an exception applies).
Under the current rules, a participant who has, or who can scrape together, additional funds can make a rollover into an IRA or eligible employer plan that will accept it. For example, if the loan offset amount is $1,000, the participant can within 60 days use his or her own funds and make a rollover contribution of $1,000 into an IRA or other eligible employer plan so as to avoid the taxation of the imputed loan offset distribution.
Under the Act, the period during which a qualified plan loan offset amount may be contributed to an IRA or other eligible retirement plan as a rollover contribution is extended from 60 days after the date of the offset to the due date (including extensions) for filing the participant’s federal income tax return for the taxable year in which the plan loan offset occurs. However, the extended deadline is available only if the plan loan offset amount arises by reason of the termination of the plan or the failure to meet the repayment terms of the loan because of the employee’s separation from service, whether due to layoff, cessation of business, termination of employment, or otherwise.
Observation: The loan offset rollover deadline is not a plan qualification rule. Therefore, plan documents typically will not be required to be revised to reflect this change in law. However, employers will wish to review and revise as appropriate information provided to participants regarding their plan loan programs. In addition, if a plan includes a plan loan feature, the IRS tax notice provided to participants who are eligible for distribution (now entitled “Your Rollover Options”) should be revised to make mention of the new favorable loan offset rollover deadline.
IRA Conversions and Recharacterizations
Currently, if an individual makes a contribution to an IRA (traditional or Roth) for a year, the individual is permitted to recharacterize the contribution as a contribution to the other type of IRA (traditional or Roth) by making a direct transfer to the other type of IRA before the due date for the individual’s income tax return for that year. In the case of a recharacterization, the contribution will be treated as having been made to the transferee IRA (and not the original, transferor IRA) as of the date of the original contribution. Both regular contributions and conversion contributions to a Roth IRA can be recharacterized as having been made to a traditional IRA.
Under the Act, the special rule that allows a contribution to one type of IRA to be recharacterized as a contribution to the other type of IRA does not apply to a conversion contribution to a Roth IRA. In other words, recharacterization cannot be used to unwind a Roth conversion. However, recharacterization is still permitted with respect to other contributions. For example, an individual may make a contribution for a year to a Roth IRA and, before the due date for the individual’s income tax return for that year, recharacterize it as a contribution to a traditional IRA.
Increase in Allowable Volunteers’ Service Award Benefits
Benefits solely representing length of service awards to bona fide volunteers (or their beneficiaries) on account of qualified services performed by the volunteers are not subject to tax rules that typically would require the taxation of such awards when earned vested. Rtypically applicable to deferred compensation arrangements. Instead, benefits under a length of service award plan are includible in income when paid to the recipient under normal tax rules. For this purpose, qualified services consist of firefighting and fire prevention services, emergency medical services, and ambulance services. An individual is treated as a bona fide volunteer for this purpose if the only compensation received by the individual for performing qualified services is in the form of (1) reimbursement or a reasonable allowance for reasonable expenses incurred in the performance of such services, or (2) reasonable benefits (including length of service awards) and nominal fees for the services, customarily paid in connection with the performance of such services by volunteers.
Currently, the favorable deferred compensation treatment applies only if the aggregate amount of length of service awards accruing for a bona fide volunteer with respect to any year of service does not exceed $3,000. The Act increases the service award limit with respect to any year of service to $6,000, and adjusts that amount in $500 increments to reflect changes in cost-of-living for future years.
Loss of Tax Deduction for Qualified Transportation Benefits
Currently, employers that provide qualified transportation fringe benefits to employees can claim a tax deduction for the cost of such benefits. In addition, Code Section 132(f) provides for a limited exclusion of such employer-paid benefits from employee wages. In addition, an employer may allow employees to pay for all or a portion of the cost of the transportation fringe benefits on a salary reduction pre-tax basis.
Qualified transportation fringes include qualified parking (parking on or near the employer’s business premises or on or near a location from which the employee commutes to work by public transit), transit passes, vanpool benefits, and qualified bicycle commuting reimbursements.
Under the Act, employers can no longer claim a tax deduction for qualified transportation fringe benefits. The employer-provided benefits will continue to be tax exempt to employees, so Section 132(f) salary reduction arrangements will continue to be allowed. However, while the benefits will be tax-free to an employee, an employer will no longer be able to deduct the costs of those benefits.
Unrelated Business Taxable Income for Fringe Benefits
Section 501(a) exempts certain organizations from federal income tax. These tax-exempt organizations include those described in Code Section 501(c) (such as charitable organizations and social welfare organizations). In addition, most tax-exempt organizations are subject to the tax on unrelated business income. The unrelated business income tax (“UBIT”) generally applies to income derived from a trade or business regularly carried on by the organization that is not substantially related to the performance of the organization’s tax-exempt functions. An organization that is subject to UBIT and that has $1,000 or more of gross unrelated business taxable income must report that income on Form 990-T (Exempt Organization Business Income Tax Return).
UBIT will henceforth include any expenses paid or incurred by a tax-exempt organization for qualified transportation fringe benefits (as defined earlier), a parking facility, or any on-premises athletic facility.
Presumably, the purpose of this provision of the Act is to treat tax-exempt organizations somewhat equally to taxable employers in regard to the tax treatment of fringe benefits.
Temporary Suspension of Exclusion for Qualified Bicycle Commuting Reimbursements
Qualified bicycle commuting reimbursements of up to $20 per qualifying bicycle commuting month are excludible from an employee’s gross income. A qualifying bicycle commuting month is any month during which the employee regularly uses the bicycle for a substantial portion of travel to a place of employment and during which the employee does not receive transportation in a commuter highway vehicle, a transit pass, or qualified parking from an employer.
The Act suspends the tax exclusion for 2018 through 2025. It will be reinstated in 2026.
Repeal of Income Exclusion of Moving Expense Reimbursements
Qualified moving expense reimbursements provided to an employee by an employer traditionally have been excluded from an employee’s taxable income. The Act repeals the income exclusion for qualified moving expense reimbursements, other than reimbursements made to a member of the Armed Forces of the United States on active duty who moves pursuant to a military order.
Restrictions on Income Exclusion of Employee Achievement Awards
A qualified employee achievement award provided to an employee is excluded from the employee’s wages for employment tax purposes. An employee achievement award is defined as an item of tangible personal property given to an employee in recognition of either length of service or safety achievement and presented as part of a meaningful presentation.
The Act adds a definition of “tangible personal property” that may qualify as a tax-excludable deductible employee achievement award. It states that tangible personal property does not include cash, cash equivalents, gift cards, gift coupons or gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of such items pre-selected or pre-approved by the employer). It also does not include vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items.