UPDATES! How The Trump Presidency And Tax Reform May Affect Stock Compensation
In numerous ways, the presidency of Donald Trump may affect equity compensation and employee ownership. Most immediately, potential tax changes under the Republican president and the Republican-controlled Congress in 2017 or 2018 may have a meaningful impact on stock compensation.
Republican Tax Reform May Increase The Value Of Stock Compensation
It is generally expected that major tax changes will occur under Donald Trump's presidency and the Republican-dominated Congress (see a commentary issued by CCH soon after the election). However, tax reform faces numerous challenges, and enactment will take time, as explained by Tax Analysts, a tax-policy research organization.
The tax-reform framework the Trump administration and GOP Congressional leaders issued in September 2017 proposes just three income-tax rates (12%, 25%, and 35%) but does not provide details on what the income amounts for the brackets would be. It also states that Congress can decide to create a higher top rate for the wealthiest individuals, a move that would be likely to affect executives who have stock compensation. 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.
Although the framework does not seek to change the capital gains rates (15% and 20%), Trump and GOP leaders continue to seek the repeal of the 3.8% Medicare surtax on investment income, including gains from stock sales, paid by high-income taxpayers to fund Obamacare. (For more on the tax-reform principles, see commentaries from Ropes & Gray, KPMG, Andersen Tax, and PwC.) A reduction in the difference between ordinary income rates and the capital gains rates might affect tax-planning decisions, e.g. whether to hold shares at exercise, vesting, or purchase. However, as discussed by an article in Financial Advisor, the various Republican proposals include the anomalous possibility that more taxpayers could become subject to the 20% rate.
Changes may also include the elimination of the alternative minimum tax (AMT). That would be welcome news for anyone receiving grants of incentive stock options (ISOs), as currently the income spread at ISO exercise can trigger the AMT and complicate tax planning.
The Trump/GOP framework also calls for the elimination of the estate tax, which 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 assets. That would create the need for other estate-planning strategies.
Given the enormous federal budget deficit, the likely need for 60 votes in the Senate to defeat a filibuster and pass a major tax overhaul, and Trump's inexperience in the art of political compromise, there are no guarantees that these proposals will become law. One possible way to balance these tax cuts in a way that might not worsen the national debt would be to eliminate provisions that are favorable to stock compensation, such as the performance-based exception for limiting the corporate tax deduction under IRC Section 162(m).
How Do Trump And His Supporters 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 a populist 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.