The Tax Cuts and Jobs Act (“Act”) represents the most comprehensive change to the tax law in over three decades. A common question echoes, how will the new tax law impact me?
While many of the provisions of the Act, that took effect on January 1, 2018, will have a significant impact on businesses and individuals, the new tax law impacts retirement plans and employee benefits plans. Here are a few that will affect employers, employees and individuals:
Impact to Qualified Plans
Taxation of Retirement Plan Distributions
- The Act extends the period which a qualified plan loan offset amount may be contributed to a plan as a rollover contribution. Many qualified plans offer their employees loans which are secured by the balance of their retirement account. Loan payments are required to be made no less frequently than quarterly. Thus if an employee stops making payments on a loan before the loan is repaid, a deemed distribution of the outstanding loan balance generally occurs. This event subjects employees to a 10-percent early distribution tax in addition to inclusion in their taxable income for the tax year.
- In the case of a separation from employment; a plan may have provided that unpaid loans could be offset with any balances remaining in the employee’s retirement account. Previously loan offsets were treated as plan rollovers only if the offset was completed within 60 days of the employee’s separation from employment. The Act now extends the election of the offset amount from 60 days after the date of the offset to the due date (including extensions) for filing the individual’s Federal income tax return for the taxable year in which the plan loan offset occurs, that is, the taxable year in which the amount is treated as a deemed distribution from the plan. The offset may be due to the separation from employment or the termination of the plan.
Repeals the Re-characterization of Certain Contributions to Individual Retirement Arrangements (IRA)
- There are two basic types of individual retirement arrangements (IRA): traditional IRAs where both deductible and non-deductible contributions may be made, and Roth IRAs, which only nondeductible contributions may be made. Amounts held must be segregated based on the type of IRA. The segregation is because each type of IRA is taxed differently. Amounts withdrawn from a traditional IRA, excluding returns on the investments, are includable in income when withdrawn. Amounts withdrawn from a Roth IRA, under certain conditions, are considered qualified distributions and are not includible in income.
- Taxpayers generally may convert amounts in a traditional IRA to a Roth IRA and the amount converted is included in the taxpayer’s income as if a withdrawal had been made.
- The Act repeals the special rule which previously permitted individuals to re-characterize IRA contributions from either Roth contributions to traditional contributions. Under the provision of the law, a conversion contributions establishing a Roth IRA during a taxable year can no longer be re-characterized as a contribution to a traditional IRA (thereby unwinding the conversion). The law does, however, permit contributions made in a current tax year to a Roth IRA, for example, to be re-characterized as a contribution to a traditional IRA, as long as it is done in the same tax year, but the provision precludes the individual from later unwinding the conversion through re-characterization.
Impact to Non-Qualified Plans
Deferred compensation and Stock Compensation Income Tax Deferral
- The Act provides tax benefits to employees which effectively change the definitions of covered employees and may also change the rules governing when amounts are included in employees’ income and deductible by employers (knows as 83(b) elections). Generally, an employee may make a special election with respect to qualified stock transferred to them, so that no amount is included in income for the first taxable year in which the rights of the employee in such stock are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable. Income taxation can be deferred by the employee until the earlier of (a) five years, or (b) the occurrence of a specified event, such as the stock of the company being readily tradable on an established securities market, or a revocation of the election. A written plan must provide that at least 80% of the employees of the company are granted stock options or restricted stock units (RSUs) with the same rights and privileges. The 80% eligibility requirement is met only if affected employees (new hires or existing employees) are either granted stock options or RSUs for that year and not a combination of both.
- The Act also modifies the definition of performance-based compensation and commissions exceptions. The changes have a transition rule which grandfathers in any binding contracts which were in effect on November 2, 2017, and which are not materially modified after that date.