New Tax Law Eliminates Favorable Treatment of Performance-Based Compensation, Presents Opportunity to Simplify Pay Arrangements
Advocates of the new tax law, generally referred to as the Tax Cuts and Jobs Act, promised that it would “deliver more jobs, fairer taxes and bigger paychecks.” One additional consequence of the tax bill, which was signed into law by President Trump on December 22, is a decreased incentive for companies to employ complex, performance-based pay arrangements with executives in pursuit of favorable tax treatment.
For over 20 years, Section 162(m) of the Internal Revenue Code has limited the tax deduction available to public companies for compensation paid to top executives to $1 million per year, per executive, but has exempted certain “qualified performance-based compensation” from this limitation on deductibility. Subject to a limited grandfathering provision applicable to employment contracts in effect as of November 2, 2017, the new tax law eliminates the exemption for performance-based compensation in its entirety, thus putting all forms of compensation, whether performance-based or not, on equal footing from a tax perspective.
Streaming giant Netflix wasted no time in adjusting its executive compensation program accordingly. In a Form 8-K filed on December 28, the company disclosed that it would eliminate performance bonuses and substantially increase base salaries for several of its top executives in 2018. Netflix cited the tax bill’s elimination of the exception to the $1 million deductibility cap for performance-based compensation as the reason that all cash compensation to the affected executives would simply be paid as salary in 2018.
For more, read this Market Watch report titled “New tax law spells big changes for companies’ approach to executive compensation.”