UPDATES! How The Trump Presidency And Tax Reform May Affect Stock Compensation
In numerous ways, the Trump presidency and a Republican-controlled Congress are affecting equity compensation and employee ownership. With effect from 2018 onward, tax reform will have a meaningful impact on stock compensation.
Tax Reform: Provisions Affecting Stock Compensation
The newly adopted "Tax Cuts & Jobs Act" has provisions that directly and indirectly affect stock compensation, whether in personal financial planning or in company stock plan administration. (See an interactive version of the legislation from the law firm Davis Polk.)
The core tax treatment of stock compensation has not changed. Below are the provisions that affect in some way the individual taxation of stock compensation. (The individual tax rates and AMT changes end after 2025, reverting to the current rates unless extended.)
Provisions Affecting Stock Compensation
1. Changes in the rates of individual income tax. The Tax Cuts & Jobs Act keeps the current seven tax brackets, reducing the rates and changing the income thresholds that apply. The new rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%, with the top bracket starting at $600,000 for joint filers ($500,000 for single filers).
The flat supplemental rate of federal income tax withholding on stock compensation is based on the seven brackets. For amounts up to $1 million it is linked to the third lowest rate (22%), although this awaits clarification by the IRS. For amounts over $1 million it is linked to the highest rate (37%). The 22% rate of withholding may not cover the actual taxes you will owe, so you need to know the tax bracket for your total income and assess the need to put money aside or pay estimated taxes.
2. Changes in the calculation of the alternative minimum tax (AMT). The income spread at incentive stock options (ISOs) exercise can trigger the AMT, which warrants complex tax planning. While the AMT or how it applies to ISOs is not repealed, below are the new numbers in the AMT calculation (to be adjusted annually for inflation).
- The 2018 AMT income exemption amount rises to $70,300 (from 54,300) for single filers and to $109,400 (from 84,500) for married joint filers.
- The income where this AMT income exemption starts to phase out in 2018 is substantially adjusted upward to begin at $500,000 for individuals (from $120,700) and $1,000,000 (from $160,900) for married couples.
These higher AMT income exemption amounts, and the much higher income point where the phaseout starts, make it much less likely that ISOs will trigger the AMT. With fewer employees at risk of triggering the AMT by exercising ISOs and holding the shares, companies may start to grant ISOs more frequently, given their potential tax advantages for plan participants.
What pays in part for this change in the AMT calculation is the $10,000 cap on the deduction for state and local income taxes and real-estate property taxes on tax returns. Given the odd way in which the AMT is calculated, those deductions may have triggered or added to your AMT in the past. Strangely enough, given that new cap, a taxpayer who has been paying the AMT may see less tax savings than they might otherwise expect to get from the AMT change.
3. New type of qualified stock grant for privately held companies. The final legislation adopted as one of its provisions a version of the Empowering Employees Through Stock Ownership Act. This provision lets an employee in a privately held company elect to defer taxes at option exercise or RSU vesting for up to five years as long as the company's equity awards meet certain conditions (the version of this provision that passed the House in 2016 allowed seven years). For details on the provision when it was part of the Empowering Employees Through Stock Ownership Act, see the coverage in the myStockOptions.com Blog.
4. No change the capital gains rates (15% and 20%). 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. While there is no change in these rates, the tax law creates a new income threshold for when the rate on long-term capital gains and qualified dividends goes from 15% to 20% ($479,000 for married joint filers and $425,800 for single taxpayers). That threshold is no longer similar to that of that top tax bracket.
Furthermore, while the Republican Congress did not seek to alter the capital gains rates themselves, they do still want to repeal the 3.8% Medicare surtax on investment income, including stock sales, that is paid by high-income taxpayers to fund Obamacare. The new tax law simply repeals the penalty for not buying health insurance.
5. Repeal of the performance-based exception to the Section 162(m) limit on deductible compensation. Publicly traded companies will no longer be able to deduct annual performance-based compensation (e.g. stock options, performance shares) in excess of $1 million for the CEO, CFO, and the top three highest-paid employees. For compensation paid under written plans existing as of November 2, 2017, an exemption applies as long as the plan is not modified. While that repeal does not affect financial planning, it further reduces the incentive for companies to favor one type of equity award over another.
What Could Have Been: Provisions Deleted During The Legislative Process
Two provisions that would have had a major impact are no longer a concern.
1. Cost basis of securities. The Senate bill sought to eliminate the ability to specifically identify any stock sold for the purposes of determining gains and losses, providing instead that stock will be considered to be sold on a "first in, first out" (FIFO) basis. The final bill does not have this provision.
2. Taxation of stock compensation at vesting. Under proposals initially made in both the House and the Senate bills but later dropped, stock and nonqualified deferred compensation (NQDC) would have become taxable once there was no longer a substantial risk of forfeiture.
How Do Trump And Republicans View Stock Compensation?
What is the president's own attitude toward stock compensation? Does he have one?
To get a sense of Trump's views on stock comp, the myStockOptions staff did some in-depth research into SEC filings made by him and his companies. In 1995, the board of Trump Hotels & Casino Resorts adopted what it called its 1995 Stock Incentive Plan, which it amended in 1996 to increase the number of authorized shares it could issue (see pages 20–22 of the company's 1996 proxy statement). Trump himself received 500,000 stock options per year between 2000 and 2002 (see the tables, text, and footnotes on pages 16–18 of the company's 2003 proxy statement). Later, when Trump was chairman of the board at Trump Entertainment Resorts, the company adopted a stock plan at its 2005 annual meeting as part of its reorganization, and it canceled its prior plan and all of the grants made under it (see Proposal 3 on page 35–41 and Annex A of the company's 2005 proxy statement).
Like other senior executives, Trump had to file Form 4 with the SEC to report his grants under the rules of Section 16 (see, for example, the reporting of his 2002 grant). Therefore, we can assume that Trump is familiar with stock options and restricted stock, though his company's subsequent bankruptcy eliminated the value of its grants.
It doesn't take a degree from "Trump University" to know that stock compensation made broadly to a company's employees, along with employee stock purchase plans and other forms of employee ownership (e.g. ESOPs), are a form of egalitarian capitalism that can spread a company's wealth and reduce income inequality (see the recent commentary on that topic in this website's blog). Trump's supporters seem likely to approve of such an approach to employee compensation. However, the recent narrowing of stock grant eligibility and the huge equity comp gains made by senior executives have perhaps given stock compensation an elitist image that Trump's blue-collar supporters can be expected to find deplorable.
Outlook For The Future
With little risk of tax increases in 2018, there is no pressing tax-law reason to accelerate income into 2017. You may even be considering the opposite (e.g. to defer 2017 income) if you think that your tax rates will be lower next year. However, tax-rate predictions should never be the only planning consideration for stock options and company stock at year-end. Instead, you may want to let investment objectives and personal financial needs, not tax considerations, drive your year-end planning.
In the long term, your company's stock price, not tax legislation, is likely to be the most crucial factor for your equity compensation. When a stock price falls after grant or becomes excessively volatile, equity grants tend to lose their perceived value (even if stock options do not actually go underwater). Therefore, if stock prices continue to perform well and we avoid the falling prices of a bear market, we can perhaps reasonably expect that stock compensation, ESPPs, and employee ownership will continue to thrive, especially when these opportunities are granted broadly to most or all employees in an egalitarian way. Additionally, the success of stock compensation depends not only on a company's share price but also on the efficacy with which it both communicates its stock plan to employees and provides them with educational resources on their grants.