Publish Date

Dec 12, 2017

2017 Year-End Planning Opportunity Related to Executive Compensation Changes in the Proposed Tax Legislation

A&M Tax Advisor Weekly

With tax reform potentially effective in 2018, companies may wish to accelerate their deductions for compensation-related liabilities into the current year. If corporate tax rates are cut in the coming year, as proposed by the House of Representatives, the value of the deduction for business expenses, including the deduction for compensation expense recognized under an annual or long-term incentive compensation plan, would be reduced. Accelerating the payment or accrual of compensation related liabilities would allow a corporation to capture a more valuable deduction.

Accelerating Long-Term Incentives

For annual incentives, taking a deduction in 2017 for amounts to be paid in 2018 may require some additional planning before year’s end. Most businesses pay bonus or annual incentive plan payments in the first quarter of the year following performance, requiring employees to be employed on the payment date to avoid forfeiting the payment. Because the forfeiture provision means that the company’s liability is not fixed until all bonuses are paid, amounts paid under this plan design are not deductible until actually paid to employees.

It is possible to take a deduction in the current year for bonuses that will actually be paid in the succeeding year, provided certain requirements are met. First, the liability for bonuses must be fixed by year-end. Thus, the company must establish a “bonus pool” from which bonuses will be paid. Second, the total amount paid may not be contingent on any future event. Therefore, the full bonus pool must be paid out, and any bonus that is forfeited by a participant must be reallocated to other participants in the bonus plan. By amending bonus plans as necessary to accommodate this approach, and by taking the requisite corporate action to fix the bonus pool before year-end, bonuses to be paid in 2018 may be deducted in 2017. (Publicly traded companies should ensure that this approach will continue to satisfy the performance-based exception to the $1 million deduction limitation as applicable to their five highest-paid executives under Code Section 162(m).)