Article

Tax reform proposals: potential implications for retirement and other benefit programs

A new administration prepares to lead the U.S.

January 20, 2017
| United States

A new environment

President Trump and the Republican-controlled House and Senate intend to simplify the tax code, cut marginal tax rates for corporations and individuals, and reduce capital gains taxes. They also want to enable global companies to repatriate overseas cash reserves at relatively low tax rates. The lower tax rates would be accompanied by a broader tax base, as elected leaders plan to eliminate or reduce at least some tax credits, deductions and exclusions now available to businesses and individuals.

Implications for employers: taxes and compensation

Corporate taxes

Employers may want to consider funding their retirement, retiree medical and other benefit plans before a possible drop in tax rates.

Here are some factors to consider:

  • Higher deductions on contributions
  • Taking advantage of current tax credits (Section 199)
  • Potential change in tax rate adds rationale for borrowing to fund plans now
  • Opportunity to shift liability from nonqualified to qualified plan paired with increased funding
  • From an accounting perspective, increased funding reduces deferred tax asset and increases deferred tax liability — lowers P&L loss when tax reform is eliminated
  • Stronger case for advance pension funding

Also, in light of potential changes, if a pension plan sponsor expects to terminate a plan within a few years, the sponsor may want to accelerate the timeline.

Employers may want to consider funding their retirement, retiree medical and other benefit plans before a possible drop in tax rates.

Individual taxes

Increase in the current after-tax value of nonqualified deferred compensation already accrued:

  • Before tax reform, the attractiveness of Roth decreases.
  • After tax reform, the relative value of tax-advantaged contributions decreases.

Compensation

When setting goals for incentive plans, employers should consider the following potential changes related to taxes and accounting:

  • Possible reduction in corporate tax rates
  • One-time tax holiday on repatriated cash
  • Changes to revenue-recognition rules
  • Slight shift in the relative pay mix with potentially lower capital gains taxes and higher interest rates
  • More variable and less fixed compensation versus the current state
  • More long-term and less short-term compensation versus the current state
  • Potentially less interest or participation in deferred compensation programs

Challenges and opportunities: implications for compensation and retirement programs

The potential for reduced corporate tax rates may present near-term financial opportunities, including some to consider before changes are enacted. Over the longer term, changes to the tax code could also create significant changes to benefits, compensation and Total Rewards strategies.

President Trump’s proposed highest marginal corporate tax rate:

From 35% to 15% with no alternative minimum tax

  • Creates challenges for deferred compensation and executive compensation programs
  • Creates advance funding opportunities for pension, retiree medical and other benefit programs
Individual Current law House of Representatives President
Highest marginal income tax 39.6% 33% 33%
Alternative minimum tax Applies Eliminated Eliminated
Estate tax Applies above threshold Eliminated Eliminated
Capital gains, dividends 20% 50% excluded, remainder at marginal tax rate 20%
Interest income Same as marginal tax rate Same as capital gains Same as marginal tax rate
Deductions Numerous, complicated Larger standard deductions; itemized deductions other than charitable contributions and home mortgage interest eliminated Larger standard deduction; cap on itemized deductions
Highest marginal income tax 35% 20%, no alternative minimum 15%, no alternative minimum
Net interest expenses on future loans Deductible Not deductible Manufacturing companies would have the option to expense capital investment or deduct corporate interest
Cost of capital investment Depreciation amortized Immediately deductible TBD
Section 199 and other business credits Allowed Eliminated except for R&D Generally eliminated, except for R&D
Taxation of foreign income Deferred until repatriated, with credits Territorial, more competitive No deferral, but credits remain; more competitive
Deemed repatriation of currently deferred foreign profits No 8.75% for cash; 3.5% for other profits One-time 10% on cash

Practical steps

  • Accelerate pension plan contributions.
  • Monitor capital market reactions.
  • Review the pension asset strategy/mix.
  • Plan for the possibility of increased retirements.
  • Shift nonqualified pension liability to a qualified plan and fund.
  • Fund retiree welfare liabilities via a qualified trust (VEBA) or a pension plan (401(h) account), or settle these liabilities via a tax-effective annuity.
  • Fund incurred-but-not-reported (IBNR) claims for the active medical plan in a qualified trust (VEBA) before tax reform effective date to ensure a larger tax deduction.
  • Maintain the status quo through the relative pay mix.
  • Anticipate likely changes when setting goals for the 2017 annual bonus and long-term compensation plans.

How Willis Towers Watson can help

While nobody can accurately predict how tax reform will evolve under the Trump administration, employers should begin to identify, prioritize and advocate for the tax relief most important to them.

Talk with a Willis Towers Watson senior strategist about contribution and benefit strategies that can help your organization be well positioned for changes that may occur.

Willis Towers Watson is not a tax advisor. We recommend you involve your tax advisor in the consideration of potential actions.