Tax Act Alters Executive Pay, Affects Bonus Deductions and Withholding

Employers should consider convening their compensation committees—possibly during this holiday season

Stephen Miller, CEBS By Stephen Miller, CEBS December 21, 2017

The enactment of the 2017 tax act, which limits the tax deductions that businesses can claim for certain employee benefits, is likely to cause some employers to revisit their executive compensation programs.

The legislation, informally known as the Tax Cuts and Jobs Act, changes the taxation of executive compensation in several ways. Most significantly, it:

  • Amends Internal Revenue Code Section 162(m)—which prohibits publicly held companies from deducting more than $1 million per year in compensation paid to senior executive officers—to eliminate the exemption for commission- and performance-based pay. The legislation also expands the scope of covered individuals to include CFOs, along with an organization's CEO and three highest-paid employees, beginning in 2018.

A transition rule applies to remuneration provided under a written binding contract that was in effect on Nov. 2, 2017, and was not modified in any material respect after that date.

"The exemption for performance-based compensation turned out to be a far bigger loophole than had been imagined" when section 162(m) was enacted in 1993, explained John Lowell, a partner with October Three Consulting in Atlanta. "Many companies saw this as a license to offer base pay of $1 million to their CEO while offering incentive pay—some only very loosely incentive-based—without limits while taking current deductions."

Removal of the exclusion for performance-based pay "is by no means the end of the need to align executive pay and performance," said Deb Lifshey, managing director of pay consultancy Pearl Meyer & Partners in New York City. "Clearly, shareholders and proxy advisors will continue to scrutinize programs for pay and performance alignment."

  • Creates a 20 percent excise tax for nonprofits—including 501(c)(3) and 501(c)(6) organizations—on the compensation of the five highest-paid employees who earn more than $1 million. The compensation is treated as paid when there is no substantial risk of forfeiture.

"The overall purpose of new section 4960 is to subject tax-exempt entities such as section 501(c)(3) organizations to the same types of constraints that publicly traded corporations are subject to under [section] 162(m) of the Code with respect to compensation paid to officers and highly compensated individuals," a law alert from the Wager Law Group in Boston explained.

Win Some, Lose Some

Other changes that will affect executive compensation include the reduction of the top federal income tax bracket from 39.6 percent to 37 percent, leaving top earners with additional net income. In addition, far fewer households with earnings between $200,000 and $500,000 will be subject to the Alternative Minimum Tax (AMT). 

The AMT exemption amount has been increased to $70,300 (single) or $109,400 (married) from $54,300 (single) and $84,500 (married). The individual AMT phase-out thresholds have been increased to $1 million for married taxpayers filing a joint return and $500,000 for all other taxpayers. Currently, the phaseout for joint filers begins at $160,900 and for other filers begins at $120,700.

However, for highly compensated employees in high tax jurisdictions, deductions for state, local and property taxes combined will be capped at $10,000.

[SHRM members-only toolkit: Designing Executive Compensation Plans]

Steps to Consider

Compensation advisers are recommending that employers:

  •  Review compensation arrangements.
    Affected employers should "be prepared to convene their compensation committees—possibly during this holiday season—to make important decisions on compensation arrangements for their top officers," advised Melissa Ostrower, a principal with Jackson Lewis in New York City, and Alec Nealon, of counsel at the firm. 

In particular, "tax-exempt entities should review their existing executive compensation arrangements now and consider whether any changes should be made," they recommended. "Tax-exempt entities should consider including protective language in any new executive compensation arrangements that would allow them to modify or reduce compensation to the extent needed to avoid the new excise taxes."

  • Consider accelerating bonus deductions.
    The final bill provides for a 21 percent corporate tax rate beginning in 2018, down from the current 35 percent rate. The bill would not change the treatment of bonus deductions, "but lower corporate rates may encourage companies to accelerate bonus deductions into 2017," said Carol Silverman, a principal with HR consultancy Mercer in New York City.

Bonuses are generally deducted in the year paid and most employers pay bonuses in the year after the employee performs the services being rewarded. However, for companies using accrual-basis accounting, "businesses can deduct amounts for bonuses earned in the performance year if the bonus is paid within 2½ months of year-end, as long as performance-related goals are met before year-end and the amount can be determined with reasonable accuracy," Silverman noted.

"Deductions in 2017 are worth more than they are in 2018," said Lifshey. "Generally, bonus payments made by March 15, 2018, are deductible in 2017 and would not need to be accelerated to take advantage of 2017 deductions."

"Companies are also considering accelerating vesting or payment of equity awards into 2017," Lifshey added.

If either cash or equity awards are accelerated to 2017, "companies must make sure all section 162(m) requirements are met," Lifshey advised. These requirements include certification of performance during the period by the compensation committee, which also may require a special meeting.

Accelerated payments and deductions should be consistent with company policies, and may be limited by accounting and other tax rules under section 409A, Lifshey said.

Altered Tax Rates and Withholding

The newly enacted legislation significantly alters tax brackets and income ranges starting Jan. 1, 2018.

Under the new tax legislation, the number of tax brackets remains at seven but the tax rates are lowered and income ranges are different.

  • Old tax rates: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and 39.6 percent.
  • New tax rates: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and 37 percent.

2018 Tax Rate Single Married Filing Jointly
10%$0 to $9,525$0 to $19,050
12%$9,525 to $38,700$19,050 to $77,400
22%$38,700 to $82,500$77,400 to $165,000
24%$82,500 to $157,500$165,000 to $315,000
32%$157,500 to $200,000$315,000 to $400,000
35%$200,000 to $500,000$400,000 to $600,000
37%Over $500,000Over $600,000
As compared with:

2017 Tax Rate Single Married Filing Jointly
10%$0 to $9,325$0 to $18,650
15%$9,325 to $37,950$18,650 to $75,900
25%$37,950 to $91,900$75,900 to $153,100
28%$91,900 to $191,650$153,100 to $233,350
33%$191,650 to $416,700$233,350 to $416,700
35%$416,700 to $418,400$416,700 to $470,700
39.6%Over $418,400
Over $470,700

View tables showing the new 2018 rates and income ranges for single, married filing jointly, married filing separate, and head of household versus 2017 rates and ranges.

Update: IRS Issues New Withholding Tables for 2018

The IRS released new withholding tables for 2018 on Jan. 11. Employers were told to adjust employee withholding rates by Feb. 15, 2018. Workers do not need to resubmit Form W-4.

HR compensation and payroll managers should work with their internal payroll departments and payroll vendors to ensure that their systems are appropriately adjusted in light of the IRS guidance. 

See the SHRM Online article IRS Releases New Withholding Tables for 2018.

The new tax rates and related salary ranges will affect employees' tax withholding decisions. The IRS encourages wage earners to consider a tax withholding checkup. By adjusting Form W-4, Employee's Withholding Allowance Certificate, taxpayers can ensure that the right amount is being withheld from their paychecks so that they don't overpay on taxes during the year, to be refunded after filing their tax returns, or pay too little and face an unexpected tax bill.

The level of income that is subject to a higher tax bracket also can influence how much salary to defer into a traditional 401(k) plan, which reduces taxable income for a given year by the amount contributed, or whether to participate in a nonqualified deferred income plan, if that option is available through the employer.

The 2017 tax act also states that among other income tax adjustments for 2018:

  • The deduction for personal exemptions, which had been $4,050 for 2017, is suspended until taxable years after Dec. 31, 2025.
  • The standard deduction for single taxpayers and married taxpayers filing separately rises to $12,000 from $6,350.
  • The standard deduction for married taxpayers filing jointly returns rises to $24,000 from $12,700.
  • The standard deduction for heads of household rises to $18,000 from $9,350.

Related SHRM Articles:

Responding to the Tax Act's Executive Compensation Changes, SHRM Online Compensation, January 2018

IRS Releases New Withholding Tables for 2018, SHRM Online Compensation, January 2018

Walmart Attributes Higher Starting Wage, Expanded Benefits to Tax Reform, SHRM Online Compensation, January 2018

Employers Giving Out Tax Cut Bonuses—or Is It Posturing?, SHRM Online Compensation, December 2017

SSA Revises Payroll Tax Cap for 2018; Tax Bill Alters Rates and BracketsSHRM Online Compensation, updated December 2017

Congress Passes Tax Bill Altering Employee Benefits, SHRM Online Benefits, December 2017

Was this article useful? SHRM offers thousands of tools, templates and other exclusive member benefits, including compliance updates, sample policies, HR expert advice, education discounts, a growing online member community and much more. Join/Renew Now and let SHRM help you work smarter.



Hire the best HR talent or advance your own career.


HR Daily Newsletter

News, trends and analysis, as well as breaking news alerts, to help HR professionals do their jobs better each business day.