The Trump administration and Republican leaders in Congress released an outline of a joint framework for tax reform in September 2017. It leaves many decisions and details for Congress to work out.
The proposals in the framework that would affect stock compensation include the following.
1. Simplification of individual income tax rates. The framework outlines just three proposed income-tax rates (12%, 25%, and 35%) without any details on what the income amounts for the brackets would be. The framework also gives Congress the prerogative to create a higher top income tax rate for the wealthiest individuals, in addition to the three tax rates presented. This would almost certainly apply to executives with stock compensation, and it is possible that for some of them the current top rate of 39.6% will remain. How changes in income-tax rates would tie into the flat supplemental rate of withholding on stock compensation is unclear and would need clarification, as the structure of the rate is based on the current seven tax brackets.
2. No change the capital gains rates (15% and 20%), but a cut in tax on investment income. A reduction in ordinary income rates would lower the difference between your income tax rate and your capital gains rate. This reduced differential might affect your tax-planning decisions, e.g. whether to hold shares at exercise, vesting, or purchase. Furthermore, while Trump does not seek to alter the capital gains rates themselves, he does want to the repeal of the 3.8% Medicare surtax on investment income, including stock sales, that is paid by high-income taxpayers to fund Obamacare. The Medicare surtax is also targeted for elimination by the separate legislation to repeal and replace Obamacare.
myStockOptions.com has found that individuals and their advisors often develop strategies to avoid the 3.8% Medicare surtax. If it were eliminated for tax years after 2017, that planning need would go away in 2018. However, for the remainder of 2017, you would want to consider whether you can defer income (e.g. NQSO exercises) into 2018 if that income would push you over the threshold for triggering the Medicare surtax in 2017.
3. Termination of the alternative minimum tax (AMT). Among those who receive grants of incentive stock options (ISOs), much rejoicing would occur if the AMT were repealed. Currently, the income spread at ISO exercise can trigger the AMT, which warrants complex tax planning. However, what could fund the end of the AMT is the elimination of the deduction for state and local income taxes and real-estate property taxes on your regular tax return. Given the odd way the AMT is calculated, those deductions can trigger the AMT. Should they be eliminated along with the AMT, taxpayers with ISOs might see less tax savings than they would expect to get from the end of the AMT.
4. Elimination of the estate tax. That would end the need to implement most gifting strategies with company stock, including those involving transferable stock options. However, estate-tax repeal might also end the step-up in the basis of investments, such as company stock, that currently occurs with a deceased person's holdings. That would create the need for other estate-planning strategies.
Don't expect the Trump/GOP framework for tax reform to become adopted legislation soon. As an article by The New York Times pointed out in April 2017, when Trump issued his initial one-page outline of tax-reform principles, numerous political obstacles stand in the way of tax reform. In addition, as the political news website The Hill reports, the lack of detail in the tax-reform plan is setting off aggressive lobbying efforts, which will take time to play out. Nevertheless, an article from Bloomberg reports that some economists believe tax cuts will be effective before the Congressional midterm elections in November 2018.
Ironically, all of this talk about tax cuts since the election has prompted some taxpayers to delay recognizing income, such as gains from selling appreciated company stock. This has meaningfully lowered government tax revenues. An article in The Washington Post reports that, according to federal data and the anecdotal experiences of tax advisors, wealthy taxpayers seem to be "postponing cashing out on investments and other financial decisions, hoping to pay less later if the White House and Congressional Republicans pass a huge reduction in tax rates" (see Americans Are Taking Their Sweet Time Paying Taxes, And The Government Is Running Out Of Cash, June 1, 2017).
Tax Brackets Matter
For the many upper-middle-class employees and managers who receive stock compensation, there is an important issue to follow with any type of tax reform (though we remain uncertain about whether the current proposals represent reform, simplification, or just a big tax cut). That issue involves the taxable income that would fit into the three proposed tax brackets. Journalists in the news media tend to focus on the tax rates themselves, not the tax-bracket thresholds, which are also significant aspects of any tax law.
This could mean that anyone currently in the tax brackets between 25% and the new highest bracket would suddenly be pushed into the top bracket, sticking them with a higher rate both on ordinary income and on short- and long-term capital gains. (The 20% top rate on long-term capital gains and qualified dividends is currently tied to the top income-tax bracket.) For example, in 2017 if you have taxable income between $153,100 and $416,700 (married, filing jointly) or $91,900 and $416,700 (single), you are currently in the 28% or 33% tax bracket. Aside from the most senior executives, individuals with stock compensation tend to be in that income range.
For more on the tax-reform principles in the framework proposed by the Trump administration and GOP Congressional leaders, see commentaries from:
In addition to the potential impacts discussed in this FAQ, the NASPP blog covers further ways in which the proposals could affect stock compensation.