Lesser-Known Tax Reform Provisions That May Affect Retirement Plan Sponsors
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act, the most comprehensive reform of the Tax Code in over 30 years. While there are few provisions that directly affect retirement plans (see our recent Compliance Alert for more details), there are a few lesser-known provisions of the new law that may indirectly affect retirement plan sponsors:
- New tax deduction for pass-through businesses — Certain pass-through entities, such as non-professional partnerships, S-Corporations, and sole proprietorships, benefit from a 20% tax deduction on their net business income. This causes the income of their business to be taxed at a lower rate than the individual tax rate (though not as low as the new corporate tax rate). While this is generally positive for small businesses, a presumably unintended consequence is that it provides a business owner less incentive to shelter income in vehicles such as a qualified retirement plan. The reason is that by contributing to a qualified retirement plan, the business owner would be deferring income that would currently be taxed at a lower rate to a time period when it will presumably be taxed at a higher rate (since retirement plan distributions are not income that is eligible for the pass-through deduction). Though there are many other reasons for small businesses to establish retirement plans (such as to attract and retain employees), removing some of the direct tax incentive for business owners to establish these plans may result in fewer retirement plans being established, which is not good for affected employees.
- New 21% excise tax on compensation in excess of $1 million earned by certain employees of tax-exempt/governmental entities — Beginning in 2018, this new tax applies to the top five highest paid employees (or former employees) in a tax year. For healthcare organizations, however, it should be noted that amounts paid directly to certain medical professionals for the performance of services are excluded. While this provision does not directly affect retirement plans, there may be an indirect effect due to the type of compensation that counts for determining the excise tax. For example, 457(f) deferred compensation that is vested (no longer subject to a substantial risk of forfeiture) counts toward the $1 million threshold, but other types of plan contributions, such as qualified plans, 457(b) plans, and 415(m) plans for public employers, would not count as compensation. Thus, it is possible that opportunities exist for highly-paid employees in these plans to defer additional income not subject to the excise tax. And finally, some employers may have accelerated the vesting for 457(f) deferred compensation that would have normally vested in 2018 (and would be subject to the new excise tax if the employee earned in excess of $1 million) to 2017 to avoid the excise tax. Presuming that this was done at the last minute (since there were only 10 days from the law’s signing to its effective date), this action may create recordkeeping issues for 457(f) plans.
While other tax reform provisions have received a lot more press (C-Corp tax rates, removing the individual mandate for the ACA), these lesser-known provisions have the potential to become particularly burdensome for affected employers.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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