While it's not quite tax "reform," at least for individual taxation, major tax-law changes have now been adopted. The Tax Cuts & Jobs Act has provisions that directly and indirectly affect stock compensation, whether in personal financial planning or in company stock plan administration. (See a handy interactive version of the legislation from the law firm Davis Polk.) Compared with some earlier proposed provisions that didn't survive the legislative process, these are not really significant beyond the change in the alternative minimum tax (AMT), which affects incentive stock options.
The core tax treatment of stock compensation has not changed. Below are the provisions that affect individual taxation of stock compensation. (The individual tax rates and AMT changes end after 2025, reverting to the current rates unless extended.)
1. Changes in the rates of individual income tax. The Tax Cuts & Jobs Act keeps the current seven tax brackets, reducing the rates and changing the income thresholds that apply. The new rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%, with the top bracket starting at $600,000 for joint filers ($500,000 for single filers).
The flat supplemental rate of federal income tax withholding on stock compensation is based on the seven brackets. For amounts up to $1 million it is linked to the third lowest rate (22%). For amounts over $1 million it is linked to the highest rate (37%). The 22% rate of withholding may not cover the actual taxes you will owe, so you need to know the tax bracket for your total income and assess the need to put money aside or pay estimated taxes.
2. Changes in the calculation of the alternative minimum tax (AMT). The income spread at incentive stock options (ISOs) exercise can trigger the AMT, which warrants complex tax planning. While the AMT or how it applies to ISOs is not repealed, below are the new numbers in the AMT calculation (to be adjusted annually for inflation).
- The 2018 AMT income exemption amount rises to $70,300 (from $54,300) for single filers and to $109,400 (from $84,500) for married joint filers.
- The income where this AMT income exemption starts to phase out in 2018 is substantially adjusted upward to begin at $500,000 for individuals (from $120,700) and $1,000,000 (from $160,900) for married couples.
These higher AMT income exemption amounts, and the much higher income point where the phaseout starts, make it much less likely that ISOs will trigger the AMT. With fewer employees at risk of triggering the AMT by exercising ISOs and holding the shares, companies may start to grant ISOs more frequently, given their potential tax advantages for plan participants.
What pays in part for this change in the AMT calculation is the $10,000 cap on the deduction for state and local income taxes and real-estate property taxes on tax returns. Given the odd way in which the AMT is calculated, those deductions may have triggered or added to your AMT in the past. Strangely enough, given that new cap, a taxpayer who has been paying the AMT may see less tax savings than they might otherwise expect to get from the AMT change.
3. New type of qualified stock grant for privately held companies. The final legislation adopted as one of its provisions a version of the Empowering Employees Through Stock Ownership Act. This provision lets an employee in a privately held company elect to defer taxes at option exercise or RSU vesting for up to five years as long as the company's equity awards meet certain conditions (the version of this provision that passed the House in 2016 allowed seven years). For details on the provision when it was part of the Empowering Employees Through Stock Ownership Act, see the coverage in the myStockOptions.com Blog.
4. No change in the capital gains rates (15% and 20%). A reduction in ordinary income rates would lower the difference between your income tax rate and your capital gains rate. This reduced differential might affect your tax-planning decisions, e.g. whether to hold shares at exercise, vesting, or purchase. While there is no change in these rates, the tax law creates a new income threshold for when the rate on long-term capital gains and qualified dividends goes from 15% to 20% ($479,000 for married joint filers and $425,800 for single taxpayers). That threshold is no longer similar to that of the top tax bracket.
Furthermore, while the Republican Congress did not seek to alter the capital gains rates themselves, they do still want to repeal the 3.8% Medicare surtax on investment income, including stock sales, that is paid by high-income taxpayers to fund Obamacare. The new tax law simply repeals the penalty for not buying health insurance.
5. Repeal of the performance-based exception to the Section 162(m) limit on deductible compensation. Publicly traded companies will no longer be able to deduct annual performance-based compensation (e.g. stock options, performance shares) in excess of $1 million for the CEO, CFO, and the top three highest-paid employees. For compensation paid under written plans existing as of November 2, 2017, an exemption applies as long as the plan is not modified. While that repeal does not affect financial planning, it further reduces the incentive for companies to favor one type of equity award over another.
For further details about the impact of the tax legislation on stock comp, including links to in-depth tax resources, see the extensive FAQ at myStockOptions.com on this topic.
Editor's Note: Save the date for the first myStockOptions conference! Here at myStockOptions, we are planning to hold our first-ever conference. It will be a one-day event: Financial Planning for Public Company Executives & Directors (Monday, June 18, 2018). Taking place in the Boston area, this is a must-attend national conference for financial advisors working with or wanting to counsel executives, directors, and high-net-worth employees. We have a wonderful group of expert speakers and a very substantive agenda of sessions on various stock-related and financial-planning topics. For details, see the December issue of the myStockOptions newsletter.