SEC Proposal Dives Into Long-Standing Debate About the Duties of Investment Professionals

On Wednesday, April 18th, the SEC introduced a much-anticipated package of proposed rules and formal guidance concerning the standards of conduct for financial professionals. The more than 1,000-page proposal, which emerged eight years after Congress required the agency to conduct a study on the topic, addresses whether investment advisers and broker-dealers should have identical or different standards of conduct vis-à-vis their retail customers. Covington recently published this alert, which takes a look at the four key parts of the SEC’s proposal and provides a brief overview of how the proposal interacts with the DOL fiduciary rule.

83(i) Elections: New Deferral Provision Aims to Ease Tax Burden on Employees Receiving Equity in Private Companies

Part of Our Series on the Tax Cuts and Jobs Act of 2017

When an employee exercises a stock option or receives shares of stock from the settlement of a restricted stock unit (or “RSU”), generally the employee has income based on the value of the stock received. Income tax and Social Security and Medicare (“FICA”) taxes are due, and the employer must withhold and report these taxes.

Employees of publicly traded companies usually can sell shares in the public market to cover the cost of their taxes. However, there is typically no market for shares of privately held companies, such as start-ups. As a result, employees receiving shares of a private company through a stock option exercise or RSU settlement usually must come up with the cash to pay the IRS.

The Tax Cuts and Jobs Act of 2017 (the “Act”) adds a new section 83(i) to the Code that allows certain employees of private corporations that broadly grant stock options or RSUs to elect to defer income tax for up to five years. This is referred to as an “83(i) election”.

Section 83(i) was billed as a way to make it easier for employees of start-ups and other private companies to share in their employers’ success.  However, as we explore in this post, the benefits of an 83(i) election may be limited.  As discussed in more detail below, private employers face a number of questions about how they can — and whether they will want to — offer an equity program that is eligible under section 83(i).

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HSA Family Contribution Limit Reduced for 2018

Changes to cost of living adjustments for health savings accounts (“HSAs”) by the Tax Cuts & Jobs Act of 2017 (the “Act”) caused a $50 decrease in the contribution limit for family coverage to HSAs for 2018.  The limit was reduced from $6,900 to $6,850 (original limit here; revised limit here).

This affects only 2018 contributions for employees with family coverage who have exceeded or made elections that will exceed the original HSA contribution limit for 2018.

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Significant Reductions to Deductible Pay at Public Companies

Part of Our Series on the Tax Cuts and Jobs Act of 2017

Employers generally may deduct reasonable salaries and other compensation paid to their employees. However, section 162(m) of the Internal Revenue Code imposes a $1 million annual limit on the amount of compensation that a publicly held corporation can deduct with respect to each of its “covered employees.”

The Tax Cuts and Jobs Act of 2017 substantially revises section 162(m) in ways that will significantly limit the amount of compensation that many public companies will be able to deduct.

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No Tax Deductions for Sexual Harassment Settlements with Non-Disclosure Agreements

Part of Our Series on the Tax Cuts and Jobs Act of 2017

The Tax Cuts & Jobs Act of 2017 adds a new provision to the Code, section 162(q), that eliminates deductions for settlement payments related to sexual harassment or sexual abuse “if such settlement or payment is subject to a nondisclosure requirement.”

  • The new provision also prohibits, in a separate subsection, deductions for attorney’s fees “related to such a settlement or payment.”
  • Thus, if an employee asserts a claim of sexual harassment against a coworker or supervisor, and the employer enters into an agreement to settle the claim that includes a standard confidentiality provision, neither the amount of the settlement nor any amount of the settlement allocated to attorneys’ fees can be deducted as a business expense.
  • The provision applies to payments made after December 22, 2017.

The new provision leaves several questions unresolved:

  • It does not include a definition of the phrase “related to sexual harassment or sexual abuse,” which creates uncertainty about the scope of the new prohibition, especially as applied to settlement agreements covering multiple types of employment claims in addition to sexual harassment or abuse claims.
  • It is also unclear, because of the structure of the new provision, whether the denial of a tax deduction for legal fees is independent from or contingent upon the presence of a nondisclosure clause.
  • It is unclear how the term “nondisclosure agreement” will be interpreted; for example, whether it will reach nondisparagement clauses.
  • Traditionally, plaintiff-employees have been permitted an above-the-line deduction for attorneys’ fees related to their employment claims. The new provision purports to disallow any deduction for any party to the settlement. The Act’s drafting history arguably supports a narrower interpretation, but it is hard to predict how IRS will interpret the plain language of the new provision.

Supreme Court Deals Another Blow to Sixth Circuit’s “Yard-Man Inferences”

On February 20, 2018, the Supreme Court decided CNH Industrial N.V. v. Reese, 574 U.S. ___ (2018), which raised, for the second time in three years, the question of how courts should interpret collective-bargaining agreements (“CBAs”).  Reese involved a dispute between retirees and their former employer, CNH, about whether an expired 1998 CBA created a vested right to lifetime health benefits.  In a per curiam opinion, the Court found that a straightforward reading of the CBA compelled the conclusion that retiree health benefits expired when the CBA expired in 2004.  The Court’s opinion emphasized the significance of CBA expiration dates for retiree health benefits and forcefully reiterated its decision in M&G Polymers USA, LLC v. Tackett, 574 U.S. ___ (2015), that collective-bargaining agreements must be interpreted according to “ordinary principles of contract law.”

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Repeal of the ACA’s Individual Mandate: Potential Impact on Employers

Part of Our Series on the Tax Cuts and Jobs Act of 2017

Starting January 1, 2019, the Tax Cuts and Jobs Act of 2017 (the “Act”) permanently repeals the Affordable Care Act’s tax penalty on individuals who fail to purchase minimum essential health coverage. Accordingly, any individual who is not covered by a health plan that provides at least minimum essential coverage for any month beginning after 2018 will not be required to pay a shared responsibility payment on their federal tax return.

  • The repeal does not affect the “employer mandate” which requires larger employers to offer affordable minimum essential coverage to full-time employees or potentially pay a tax penalty.
  • It also does not repeal requirements for an employer to report to the IRS and to employees information related to the employer’s health plans (including employees who have been offered, or enrolled in, the health plans).

Possible Effects on Employers

The repeal of the individual mandate could affect employers in a few ways:

  • The repeal reduces the incentive for individuals, particularly healthy individuals, to enroll in health coverage, including employer-sponsored coverage. Lower enrollment by healthy individuals could cause premiums for employer-sponsored plans to increase.
  • The potential penalties imposed on an employer that fails to offer minimum essential coverage or offers minimum essential coverage that does not meet affordability or minimum value requirements are triggered only if one or more full-time employees purchase coverage on a health exchange with federal subsidies (g., premium tax credits). Eliminating the individual mandate is expected to cause fewer individuals to obtain subsidized coverage on a health exchange. This would allow employers to at least potentially pay lower penalties related to any violations of the employer mandate, and in some cases could allow employers to potentially avoid paying any such penalties.
  • The IRS will no longer need to receive information necessary to enforce the individual mandate. Accordingly, the employer reporting requirements that are currently designed to help the IRS enforce the individual mandate may be reduced or repealed completely.

Hidden Opportunity: Deducting 2018 Pension Contributions Against 2017 Income

Part of Our Series on the Tax Cuts and Jobs Act of 2017

At the end of 2017, many businesses scrambled to find expenses before year-end that could be deducted on their 2017 federal income tax return against the higher income tax rates in effect for last year. For most expenses, the deadline to act passed on New Year’s Eve 2017. However, businesses that sponsor a tax-qualified defined benefit pension plan may have the opportunity to generate deductions on their 2017 return by making contributions to the plan during 2018.

In order to do so, the contributions will need to satisfy the general deductibility requirements for expenses, the specific deductibility requirements for pension contributions, and the minimum funding rules. This combination of requirements and rules is difficult to navigate, but in general, a deduction should be available to the extent the contribution (1) is made no later than September 15, 2018, (2) is otherwise deductible under the income tax provisions of Chapter 1 of the Code, (3) is designated as a contribution for the 2017 plan year on Schedule SB of the plan’s 2017 Form 5500, and (4) does not cause the plan to be more than 150-percent funded, measured in a very specific way provided under the Code.

The analysis and deadlines above apply to single-employer plans subject to the minimum funding requirements of Code section 430 that have a calendar plan year and are maintained by employers that have a calendar taxable year. The analysis and relevant deadlines will differ in the case of multiemployer plans, plans not subject to the minimum funding requirements of Code section 430, plans with non-calendar plan years, and plans sponsored by employers with non-calendar tax years. An analogous deduction may be available with respect to contributions to defined contribution plans, but the opportunity is likely to be more limited.

Labor Department Scraps Unpaid Intern Test and Adopts More Flexible Approach

The U.S. Department of Labor (DOL) recently announced that it will apply a new, more flexible test for determining whether interns working for “for-profit” companies are entitled to minimum wage and overtime protection under the federal Fair Labor Standards Act (FLSA). The new test is set forth in DOL Fact Sheet #71 (updated January 2018).

The FLSA requires employers to pay “employees” minimum wage and overtime. It has long been recognized, however, that certain categories of workers are not “employees” for purposes of the FLSA. This includes unpaid interns. Prior to this announcement, the DOL applied a strict test that required private employers to establish six different factors to demonstrate that workers were appropriately classified as unpaid interns. In the past few years, as litigation over the use of unpaid interns increased, that test had been rejected by courts, including the United States Courts of Appeals for the Second and Ninth Circuits. Decisions issued by those courts favored a more flexible test that holistically examines the relationship between an intern and employer to determine who is the “primary beneficiary” of the relationship.

The announcement by DOL is intended to align its enforcement policies with this more recent case law and provide DOL investigators with greater flexibility in analyzing issues involving unpaid interns on a case-by-case basis.

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Proposed Changes to UK Law on the Taxation of Payments In Lieu Of Notice

The draft UK Finance Bill 2017 (the “Bill”) proposes some significant changes to the tax treatment of a payment in lieu of notice (“PILON”) for employees.  Where a UK employer exercises a contractual right to make a PILON, the payment is fully taxable and subject to national insurance contributions (“NICs”) as income, in the same way as salary.  However, where there is no contractual right to make a PILON, and the employer chooses to terminate the employee’s contract in lieu of notice, any payment made to the employee to cover the amount that they would have received if they had worked their notice in full constitutes damages for breach of contract. Such payment could therefore be paid free of tax up to £30,000, and free of both employer and employee NICs.

The Bill proposes that, from April 6, 2018, all PILONs (contractual and non-contractual) will be taxed as income, and will therefore be subject to income tax and both employer and employee NICs. This would apply only to the basic pay that the employee would have earned during this period.

In addition, any amounts in excess of the £30,000 tax exemption are currently subject to income tax, but not to any NICs. The UK government has proposed to subject such excess to employer (but not employee) NICs. If passed, this provision would take effect from April 2019.

Although the Bill is only in draft form currently (and its scope subject to change between now and April 2018), UK employers should carefully consider any proposed terminations that may be made after April 6, 2018, in order to minimise any potential tax liabilities that could arise for both the employer and the employee.