Executives and corporate compensation committees can get out in front of these changes by evaluating and possibly taking preemptive action. Anticipated government initiatives in other areas, dependent in part on which party controls the U.S. Senate, could upend current arrangements ranging from noncompete agreements to restructured benefits, and deferred compensation strategies to new diversity and inclusion initiatives.
This article will highlight steps that companies and individual executives should consider to best prepare for the new workplace environment that may be ushered in by the election.
If the Democrats gain control of both houses of Congress, we can expect swift action on several measures based on plans published by Biden, public comments by his campaign, and legislation previously passed by the U.S. House of Representatives that saw no action in the Senate. The three main areas of immediate interest are individual incomes taxes, business taxes and the taxation of wealth transfers, all of which impact executive employees in significant ways.
Through the end of 2020, the top marginal personal income tax rate is 37%. Biden has proposed raising this to 39.6%, thereby reversing the reductions in the rates that were part of the Tax Cuts and Jobs Act, that are otherwise set to expire after 2025.
Biden proposes to apply this same 39.6% tax rate to capital gains and qualified dividends for taxpayers with incomes over $1 million. The current top rate is 20% for assets held for a year.
The Biden tax proposals would also place a limit on itemized deductions and apply the current 12.4% Social Security tax to all wages over $400,000. Currently, only the first $137,700 of earnings are subject to the Social Security tax.
Social Security taxes are split evenly between employers and employees. Consequently, under Biden's proposal for the increase in Social Security tax, the employer would see a corresponding increase in corporate payroll taxes.
Corporations would see their top marginal tax rate rise from 21% to 28%. Taxpayers with incomes over $400,000 would lose the ability to defer capital gains for like-kind exchanges of real property and would see a phaseout of the qualified business income deduction from a partnership, S corporation or sole proprietorship.
Although no specific proposals have been floated, the Democratic Party platform identifies planned changes to the carried interest rule, which allows partners to receive long-term capital gains treatment for partnership interests obtained in connection with the performance of services.
Biden has also suggested replacing the employee deduction related to dollars saved in traditional defined contribution plans to a flat-rate credit. Although the Biden campaign has not shared an exact percentage, the Urban-Brookings Tax Policy Center has suggested a possible 26% rate as being revenue-neutral.
Under current law, taxpayers may transfer up to $11.58 million without paying gift, estate or a generation-skipping transfer tax. Biden proposes to roll this back to 2009 levels, which would reduce the estate, gift and generation-skipping transfer limit to $3.5 million, and may imply an increase in the estate tax from 40% to 45%.
The Biden proposal would also eliminate the step-up in basis for inherited assets and might tax unrealized capitals gains on assets that do not pass to a surviving spouse or charity.
When Biden was vice president, the Obama administration proposed significant changes in the rules governing grantor-retained annuity trusts and irrevocable grantor trusts. These are used in estate planning to minimize taxes on large financial gifts to family members.
While candidate Biden has not announced specific plans in this area, it is anticipated that any tax bill in the new Congress could revive these earlier proposals.
Increased Liability Exposure
Taking a slightly longer lens, we can see a Biden administration working quickly to pass a host of policy initiatives that would significantly benefit organized labor and impose additional mandates on employers. Several of these proposals are likely to have a direct impact on corporate executives.
For example, Biden plans to hold corporate executives personally liable for interfering with union organizing efforts. For intentional interference, Biden proposed enhanced penalties, including personal criminal liability. Executives can also expect to see an effort to expand criminal liability for mid- to upper-level managers in companies operating high-injury workplaces.
Additional Areas of Concern
Biden's commitment to diversity and inclusion initiatives includes a mandate that employers publicize the diversity composition of both their senior leadership and overall workforce. Such publicity is expected to create additional pressure on employers to restructure the way that they chose senior leadership and may include incentives for companies to actively diversify their senior leadership ranks.
Except for states such as California, which bans the practice, most senior-level executives are covered by noncompetition agreements. Biden proposed limiting noncompete agreements to those that are necessary to protect trade secrets. This would vastly restrict the ability employers currently have to base noncompete agreements on the need to protect confidential and proprietary information that may not rise to the level of being a trade secret.
Women in executive-level positions can anticipate that a Biden administration may press legislation making it easier for them to sue their employers to correct inadvertent pay inequities.
The House of Representations previously passed legislation to invalidate predispute workplace arbitration agreements. Because such agreements are fairly routine for C-suite employees, the adoption of the proposed Forced Arbitration Injustice Repeal Act would substantially affect the ability of terminated executives to carry their disputes into public courtroom proceedings.
The Executive as Employer
Many executives also wear the hat of being the employers of domestic household staff. Biden has pledged to seek passage of the Domestic Workers Bill of Rights Act, previously introduced as S. 2112 and H.R. 3760.
This legislation would mandate overtime pay, paid sick leave benefits, and meal and rest breaks. It would also create a Domestic Worker Wage and Standards Board, charged with making additional recommendations for workplace protections.
While Republican retention of control in the Senate could cripple Biden's legislative agenda, there is much that a new administration can accomplish through regulatory measures. Many of the policy goals reflected above can be accomplished by regulations.
Expect a Biden administration to adopt a host of federal procurement regulations to make these policy changes binding on companies that do business with the federal government. Because a significant portion of the federal budget is spent under contracts with private sector employers, the Biden administration can use the power of the purse to implement broad changes in corporate practices even in the absence of any legislative changes.
The ranks of government inspectors will likely grow in a Biden administration. Combined with a less lenient approach to regulatory violations by the new administration, corporate executives can find themselves the object personally of enforcement proceedings. Environmental, climate change and worker safety programs will become the likely flashpoints, especially in companies that do business with the federal government.
A Biden administration is expected to make it easier for employers to hire and retain immigrant workers. This may open the ranks of executive-level and professional positions to talent that is currently excluded from working in the U.S.
Actions Companies Should Consider Now
Between now and year-end, there are several initiatives that executives may be pressing for their own benefit or that corporate compensation committees may be considering.
Conflicting Pressures on Compensation Committees
A significant portion of executive compensation in recent years has shifted to bonus and equity programs with pay-for-performance criteria designed to align company objectives and results with producing shareholder value. The financial impact of the pandemic on certain industries has, and may continue to produce results ranging from what might be considered windfalls to devastating losses.
Some adversely impacted companies have reduced corporate base salaries, but the vast majority of their executive compensation is delivered in incentive and equity awards which may or may not deliver value in 2020. Other companies may find their performance to have exceeded even the stretch goals set at the beginning of 2020, and are grappling with balancing the occurrence of a pandemic-related spike in performance, rewarding this outcome and the impact on sustained performance criteria.
This, together with the uncertainty of the election results, market volatility and the potential for tax increases continue to raise concerns among executives and compensation committees about the design and operation of their executive compensation strategy and programs.
The continued pressure for transparency, increasing disclosure requirements by the U.S. Securities and Exchange Commission, and pressure exerted by shareholder proxy advisory firms, as well as the added concern of public perception of executives promoting their self-interest during a pandemic, may drive compensation committees to be more hesitant about taking any immediate or significant action to address these issues.
However, the compensation committee's need to protect the interests of stakeholders and their assessment of executive and board compensation strategy — including how to set or adjust performance metrics; how to design long-term performance and retentive compensation programs; and how to enforce stock ownership guidelines — in an uncertain and changing tax and economic environment is part of its overall executive compensation oversight function and exercise of its fiduciary duties.
The compensation committee will want to thoughtfully consider the effect of their decisions and must conduct and document a thorough analysis of what is necessary to incentivize and retain management teams at a time when their dedication and performance is more important than ever and in the face of events that may be entirely outside their control.
Bonus and Equity Adjustments
Assuming a Biden administration and potential democratic control of both the House and the Senate, employers, boards of directors and executives may want to consider certain short- and longer-term adjustments to their programs in anticipation of individual and corporate tax increases.
Executives or board members nearing retirement may have very different liquidity, diversification objectives and time horizons for their personal retirement and wealth accumulation than others with longer runways on their career pathway. The potential impact of tax increases may be more serious and immediate for those with significant amounts of retirement or deferred compensation funds currently in the hands of the employer.
Conversely, executives with longer time horizons to retirement may wish to take advantage of programs for deferral of amounts payable in 2021 and thereafter. These issues may be particularly acute in the case of stock-based compensation and governance-based stock ownership guidelines, both for executives and board members, where both rate changes and changes in ordinary income or capital gains tax treatment is involved.
Decisions Before Year-End
For executives who currently have tax and financial planning benefits provided by their employer, it is likely that those discussions are ongoing and personal decisions and actions may be warranted before year-end. To that end, executives may approach the board or compensation committee requesting accelerated payment of 2020 bonuses, payouts of previously deferred compensation, institution of additional deferral options in 2021 for longer-term future payouts, and other changes to company compensation arrangements to align with their planning objectives.
Companies that discontinued or do not provide planning assistance for their executives may want to consider the benefits of doing so in the future. If existing goals will not be adjusted, committees might consider adding year-end 2020 bonus programs that reward executives for maintaining the business and providing stability to employees and the overall economy.
The proposed increase in the top marginal tax rate may incent companies to include deferral provisions in new restricted stock unit and performance share unit awards. Current cash or equity incentive plans and/or award agreements paying out in 2021 or after may not include deferral provisions, and making current amendments to allow deferral must include legal, tax and accounting considerations.
Additional factors, including SEC disclosure requirements, investor reactions, employee morale and the impact on the next say-on-pay vote are also relevant considerations.
For bonuses or awards related to services rendered after January 2021, elections to defer must be made by the end of 2020 to comply with tax rules. Assuming a qualified election, an executive would be able to shelter future compensation from federal income tax until the sheltered amount is paid or otherwise made available to the executive.
However, such deferred compensation would be subject to the increased Federal Insurance Contributions Act tax when earned, rather than when settled. The Biden tax proposal could give a boost to the more frequent use or weighting of stock options and stock appreciation rights in incentive programs. Some existing equity plans contain provisions for the use of these award types even if they are not currently being awarded, but the committee should be sure these instruments are authorized before granting awards.
A typical stock option/stock appreciation rights award has a 10-year term during which time it may be exercised, in full or in part, to the extent vested. Unlike any other equity award, this gives the award holder flexibility to determine the timing of taxation. Until exercised, any in-the-money value of a vested option/stock appreciation right is not subject to federal individual income tax, or FICA tax. At time of exercise, amounts realized are then subject to these taxes.
Of course, company tax and accounting departments (and advisers) will want to be involved in the counterbalancing of corporate tax objectives and timing of deductions based on current or projected financial performance. In any event, if a public company adopts or modifies an incentive plan or stock award to set or adjust performance targets, alter vesting or payout provisions, or to defer or accelerate payout of retirement or deferred compensation it may be required to report such adoption or modification to the SEC.
If Congress Remains Split
Without democratic control of the House and Senate the likelihood of dramatic federal tax changes is lower, but company performance, state tax increases, increased regulatory oversight and investor pressures may still drive the need for reconsideration of executive compensation approaches. In fact, companies facing net operating losses and/or cash constraints may be reticent or unable to make adjustments to benefit, retain or incent executives.
These companies may have the desire to unilaterally delay incentive payments, terminate retirement or deferral plans, or suspend making additional equity awards. Any of these actions may create potential accounting, contractual and tax issues for both the company and the executive.
Potential Risks to Anticipate
Regardless of the motivation, the amendment or termination of an existing incentive or deferred compensation plan should be carefully considered as such action can create significant tax compliance issues for companies, potential excise taxes for executives and could limit the company's ability to offer these plans in the future. Absent insolvency or a change in control, an employer may be limited or precluded from accelerating or delaying incentive payments, or terminating and liquidating a deferred compensation plan under contractual provisions, accounting, tax, bankruptcy or other rules.
Other issues may arise, especially if termination and/or liquidation is a result of a downturn in the employer's financial health or existence as a going concern. In some cases, termination and/or payout of compensation may result in the loss or reduction in value of deferred tax assets in the form of corporate deductions.
Companies with deferred and grandfathered 162(m) compensation should be especially careful in considering these actions. Further, under tax rules if a payment is made to an employee in substitution of the terminated deferred compensation plan benefit, such payment may be treated as an accelerated payment resulting in unwanted excise taxes for the executive.
Companies that terminate deferral plans must be sure that all appropriate withholding and reporting of income is accurate. It would be reasonable to expect that a reinvigorated IRS might institute an audit program for these transactions.
In addition to affecting executive compensation programs, Biden's tax proposal could incent executives to exercise options and/or sell company stock held in excess of share ownership requirements to take advantage of the current tax rate on long-term capital gains, thereby affecting the level of executive ownership of company stock and potentially creating investor concerns.
The Biden administration could revive or usher in a more robust regulatory environment at the SEC. The recent use of dual class shares for executive awards may be subject to increasing regulatory or disclosure requirements. Given the economic environment, the growth in adoption and utilization of clawback provisions and proposals regarding required deferrals and/ or ceilings on payouts of future executive incentives may be likely subjects for legislative or regulatory action.
Actions Executives Should Consider Now
Utilizing Gift and Estate Tax Exemption Amounts
For wealthy couples who would like to use their exemptions before the end of the year but retain access, at least in part, to assets they give away, one popular technique is for each spouse to create a trust for the benefit of the other spouse and their descendants. Each spouse would create a trust, otherwise known as a spousal lifetime access trust, or SLAT, and fund it to use his or her gift tax exemption.
Each spouse would also allocate his or her generation-skipping transfer exemption to the SLAT so assets held in the SLAT would not be subject to estate or generation-skipping transfer taxes for multiple generations, or possibly in perpetuity. Each SLAT enables a beneficiary-spouse to receive distributions of income and principal from the trust during his or her lifetime.
This technique is not without risk, however, and the timing of the gifts to the SLATs and the terms of each SLAT should be structured in such a way to avoid the so-called reciprocal trust doctrine, which the IRS may use to challenge this type of planning.
Conversion of Traditional IRA to Roth IRA
If the circumstances are right, executives may want to consider converting their traditional individual retirement accounts to Roth IRAs before the end of the year. Traditional IRAs act as a tax-deferral mechanism in which individuals receive an income tax deduction on contributions made to a traditional IRA, but all future distributions from a traditional IRA are subject to ordinary income tax. In contrast, contributions to Roth IRAs are not tax deductible, but future withdrawals are tax-free.
A conversion of one's traditional IRA is a taxable event and will result in the individual paying ordinary income taxes on the IRA in the year of the conversion. However, once the conversion is made, an individual will not need to pay income taxes on future distributions.
Accordingly, a conversion could make sense for several reasons. The value of one's traditional IRA could have decreased earlier this year and may not have rebounded, so a conversion may not generate as much taxable income as it would have prior to this year.
As discussed above, Biden has proposed raising income taxes and many executives may find themselves in higher-income tax brackets in future years, especially if they deferred or did not receive as much compensation this year as a result of the pandemic. Finally, the Coronavirus Aid, Relief and Economic Security Act suspended the required minimum distributions for 2020, which means that individuals could convert the entire amount of their traditional IRA without taking a required minimum distribution and paying taxes on it.
Prior to 2020, deductions on cash donations to public charities were limited to 60% of an individual's adjusted gross income. The CARES Act removed this limitation so individuals can receive a 100% deduction for gifts to public charities (but not donor advised funds) in 2020. Although income tax rates may be increased next year for high earners, if executives are charitably inclined, it may be advisable to accelerate cash gifts to public charities this year.
Setting the Stage for Longer-Term Changes
With regard to the shift to a flat credit related to saved dollars in retirement plans, companies may decide to create a stronger focus on the retirement plan as an incentive for all employees. However, the replacement of the current deduction for credit harms executives who would have historically been able to take the deduction at the 37% tax bracket and are instead forced to accept a likely lesser credit.
Companies already reconfiguring compensation packages may opt to create different compensation arrangements to help bridge the gap or may opt to add a Roth feature to their current 401(k) plan, if they have not already done so. Since change to a credit system will decrease the benefit of pretax contributions the executives may be more inclined to invest after-tax dollars which can grow in a tax-advantaged fashion.
Although Biden has not indicated that he would revive the controversial Cadillac tax under the Affordable Care Act, one change Biden's administration may make is to issue regulations regarding nondiscrimination testing for fully insured group health plans. The Affordable Care Act set into place a rule that fully insured group health plans must follow similar nondiscrimination rules that apply to self-insured plans under Section 105(h).
Implementation of this rule has been paused until further guidance, and such regulations have not been forthcoming under President Donald Trump. Given Biden's propensity to equalize retirement benefits and reconfigure the tax benefits to target higher-income individuals, under a Biden administration it appears more likely that regulations will be issued and employer arrangements providing discriminatory coverage advantageous to management, such as improved benefits or lower premiums, will be affected.
Jeff Pasek is a member at Cozen O'Connor.
Diane Thompson is of counsel at the firm.
Michael Corgan is a member at the firm.
Anne Greene, an associate at the firm, contributed to this article.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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