How Tax Reform Will Impact Executive Compensation

Speaker of the House Paul Ryan (R-WI).

The way in which many public companies have been structuring executive compensation for the past two decades will be directly impacted under recently approved overhaul of the U.S. tax system.

Executive compensation under Section 162(m) would change under the new law, with the elimination of the performance-based compensation exception that’s been is use for two decades. This means that all compensation of more than $1 million per year paid to a covered executive employee will become non-deductible in 2018 (and qualifying covered employees will be expanded to include a company’s CFO).

As a result, companies that expect an executive’s compensation to top $1 million may look to expedite those employees’ compensation from 2018 to 2017 in order to take advantage of the deductions before the new year.

“Committees will have a lot of discretion, there can be a lot of adjustments, you don’t have to have all of the performance measures approved by shareholders in your equity plan.” – Deb Lifshey, managing director, Pearl Meyer

“If you think about it just from the deduction standpoint, it could be hundreds of thousands of dollars,” Deb Lifshey, a managing director in Pearl Meyer’s New York office told Corporate Board member. “It’s a 14 percent difference, so a lot of companies are trying to shift that liability into 2017.”

There is some work involved in shifting that compensation to 2017, including establishing a minimum bonus pool to pay out to meet the all-events test to be able to take the deductibility in 2017.

“As people come and go you certify or make a board resolution that you’re going to pay out a minimum amount,” Lifshey says. “So even if people have left, you still have to recirculate those monies to other people.”

If the compensation is paid out to the covered employee within a certain timeframe, they should qualify for the lower tax rate, making the situation beneficial for both the company and the executive.

“Doing it this way is a win-win with respect to bonuses, because the company gets the benefit of the better tax deduction, yet if it’s paid out to the employee in the first 75 days of 2018 the employee should get the benefit of the lower tax rate, depending where they fall,” Lifshey says.

The new tax rules should also provide compensation committees with some new flexibility—though shareholders will still be evaluating executives based on their performance.

“What you will have is a lot of loosening up at the committee level, because committees will no longer have to dot all the i’s and cross all the t’s on the technical requirements, jumping through all these hoops for four or five people,” Lifshey says. “Committees will have a lot of discretion, there can be a lot of adjustments, you don’t have to have all of the performance measures approved by shareholders in your equity plan. It’s going to be a little more loosey-goosey, but you’ll still have a lot of oversight because shareholders will be looking for a tie of pay and performance.”