Tax Reform Update – A (Mostly) Good First Step
House Republican leaders on Nov. 2 released their much-anticipated tax reform plan that left 401(k)s and IRAs alone, but contained a number of proposals to modify various pension and retirement savings provisions.
The first wave of documents released by the House Ways and Means Committee included one confirming that the GOP tax reform proposal “…makes no changes to the popular retirement savings options that Americans have today – including 401(k)s and Individual Retirement Accounts, or IRAs.” The subsequent release of the bill text and section-by-section summary of the proposed legislation confirm that there is no proposal to reduce the limits.
These issues – and the potentially damaging aspects to retirement savings as a “pay for” other tax reform changes – have been front and center with both ASPPA and the American Retirement Association for nearly a year now. Less than two weeks ago, the ARA issued a set of “Retirement Policy Principles for Tax Reform” emphasizing not only the importance of the nation’s private retirement system, but the dangers inherent in changing current retirement savings incentives for solely for the purpose of raising revenue for other tax objectives.
It appears that, for the present, anyway, American workers, plan sponsors and the retirement industry at large can breathe a sigh of relief that the rumored changes to the pre-tax contribution limit in 401(k)s – so-called “Rothification” – are not included. That said, it is worth repeating that we are only at the very first stages of the legislative process and have yet to see what the Senate will propose, much less how it might be reconciled with what eventually comes from the House – which must first be considered and approved by the House Ways and Means Committee.
Meanwhile, an issue that has also been on the ARA’s radar for the past several months are the proposed changes regarding “pass-through” entities. The proposed changes are complex and may yet be problematic with regard to disincentivizing small business owners to establish and maintain a retirement plan for their workers. This is an issue we have raised previously (see Tax Reform Proposal Could Undermine Incentives for Small Business Plans). We are working through those provisions now and will provide an update on that in the near future.
Summary of Pension and Retirement Simplification Proposals
In addition to seeking numerous changes on the individual and corporate side, the 429-page “Tax Cuts and Jobs Act” also contains a number of proposals to modify various pension and retirement savings provisions in Section F of the bill, including provisions to simplify the recordkeeping of hardship distributions, reduce the minimum age for allowable in-service distributions and modify the nondiscrimination rules to protect older, longer service participants. These are outlined in more detail here.
Nonqualified Deferred Compensation
Another major – and as yet largely unreported – change impacts nonqualified deferred compensation. An employee would be taxed on compensation as soon as there is no substantial risk of forfeiture with regard to that compensation (i.e., receipt of the compensation is not subject to future performance of substantial services). This would have the impact of making wholesale changes to the taxation of virtually all nonqualified deferred compensation by taxing amounts earned under those plans as they vest, rather than when they are paid. This means that employees could no longer defer compensation on a tax-deferred basis to a 401(k) excess plan, since they are typically vested in the deferrals. Or more precisely, they could defer, but they would be taxed as if they had not. These changes would apply to NQDC for services performed after 2017, while existing NQDC would be taxable under current rules but no later than 2025 (or when vested, if later). We’ll have more on this provision and its potential impact next week.
The summary contends that the provision repeals a current-law tax benefit for which “only highly compensated employees are generally eligible” and would simplify an extremely complex section of the tax code. The provision is estimated to increase revenues by $16.2 billion over 2018-2027.
The legislation includes numerous changes to the individual and business tax rules, including:
- cuts to tax rates for individuals, corporations and pass-through entities;
- repeal of the individual alternative minimum tax;
- elimination of numerous existing deductions and exclusions;
- increased expensing for qualified property;
- a doubling of the exclusion for estate taxes; and
- a shift to a territorial system for taxing foreign-source income of U.S. multinational corporations.
The Ways & Means Committee made the following documents available online:
The Ways and Means Committee is scheduled to begin “marking up” the legislation on Monday, Nov. 6, with the goal of full House passage of the legislation by Thanksgiving Day. It is very possible the markup itself could take several days to complete.