The following provides an overview of these proposed changes.
Employee benefit changes and repeals
- Employee-achievement awards - The discussion draft would repeal the exclusion for employee-achievement awards, so that such awards would constitute taxable compensation to the recipient. The proposal also would repeal the restrictions on employer deductions for such awards.
- Housing - Under the proposal, the exclusion for housing provided for the convenience of the employer and for employees of educational institutions would be limited to $50,000 ($25,000 for a married individual filing a separate return). The exclusion also would be limited to one residence.
- Air transportation - The proposal would repeal the exclusion from income for air transportation provided as a no-additional cost service to the parent of an employee. For the qualified transportation fringe benefit, the proposal would set the qualified transportation fringe excludable qualified parking amount at $250 per month, and the excludable transit pass amount at $130 per month. These amounts would no longer be adjusted for inflation. The proposal would repeal the qualified bicycle commuting reimbursement. The proposal would be effective for tax years beginning after 2014.
- Unrealized appreciation in employer securities - Under the proposal, the exclusion for net unrealized appreciation in distributed employer securities would be repealed. The distributee generally would have income in the amount of the value of the distributed securities. The proposal would be effective for distributions after 2014.
Employment tax modifications
The discussion draft proposal would expand the application of employment taxes by eliminating various exemptions.
- Under the proposal, the deduction with respect to net earnings from self-employment would be modified to make SECA taxes economically equivalent to FICA
- The proposal would repeal the exemption from FICA taxes for certain foreign workers so income would be subject to FICA while in the United States on the same basis as other employees in the United States.
- The proposal would repeal the exemption from FICA taxes for certain students for services performed after 2014. The FICA exception for students would be limited to the student’s earnings that are less than the amount needed to receive a quarter of Social Security covers for the year ($1,200 for 2014).
- Under the proposal, the IRS guidance exempting certain supplemental unemployment benefit payments from payroll tax withholding would be overridden. The general tax treatment of severance benefit payments would be clarified, so that all such payments would be subject to income and payroll taxes (i.e., FICA, FUTA and RRTA).
Individual retirement accounts (IRAs)
No income limits on contributions to Roth IRAs and no new contributions to traditional IRAs
Under the discussion draft proposals, the income eligibility limits for contributing to Roth IRAs would be eliminated and new contributions to traditional IRAs and non-deductible traditional IRAs would be prohibited. The inflation adjustment of the annual limit on Roth IRA contributions also would be suspended until tax year 2024, at which time inflation indexing would recommence based off of the frozen level. The proposals would be effective for tax years beginning after 2014.
Repeal of special rule permitting recharacterization of Roth IRA contributions as traditional IRA contributions
Under the discussion draft proposal, the rule allowing re-characterization of Roth IRA contributions or conversions would be repealed. Note that under other proposals of the discussion draft, no new contributions to traditional IRAs would be permitted. The proposal would be effective for tax years beginning after 2014.
Repeal and changes
Other measures in the discussion draft would:
- Repeal the exception to 10% penalty for first home purchases. Under the proposal, the exception to the additional 10% tax for early distributions used to pay for first-time homebuyer expenses would be repealed. The proposal would be effective for distributions after 2014.
- Not allow employers to establish new SEPs or SIMPLE 401(k) plans after 2014. Employers would be permitted to continue making contributions to existing SEPs and SIMPLE 401(k) plans. SIMPLE IRAs would continue to be available. The SEP proposal would be effective for tax years beginning after 2014, and the SIMPLE 401(k) proposal would be effective for plan years beginning after 2014.
Other qualified retirement plans
Rules related to designated Roth contributions
Under the discussion draft proposals, employees would generally be able to contribute up to half the maximum annual elective deferral amount (including catch-up contributions for employees at least 50 years old, if applicable) into a traditional account.
For 2014, the maximum annual elective deferral amount would be $17,500, and the maximum catch-up amount is $5,500 (for a total of $23,000 for such employees). Any contributions in excess of half of these limits—$8,750 and $11,500, respectively—would be to a Roth account. Employees could contribute up to the entire annual elective deferral amount into a Roth account if they wish. Plans would generally be required to offer Roth accounts. Employer contributions would continue to be made to traditional accounts.
The proposal would not apply to employers with 100 or fewer employees. In addition, employers may choose to have Roth accounts in a SIMPLE IRA, and if an employer with a SIMPLE IRA elects to limit traditional employee contributions to half the annual contribution limits, the employee contribution limits to such SIMPLE IRA would be increased to the contribution limits for a 401(k) plan. For purposes of this proposal, 403(b) plans and 457(b) plans would be treated like 401(k) plans. The proposal would generally be effective for plan years and tax years beginning after 2014. The SIMPLE IRA portion of the proposal would be effective for tax years and calendar years beginning after 2014.
Modifications of required distribution rules for pension plans
Under the Ways and Means proposal, if an employee becomes a 5% owner after age 70½ but before retiring, the required beginning date for required minimum distributions (RMDs) would be April 1 of the following year. With respect to IRAs and employer-sponsored retirement plans that exist when the IRA owner or employee dies distributions would be required within five years (regardless of whether the IRA owner or employee dies before or after RMDs have begun). An exception would apply if the beneficiary is a spouse, is disabled, chronically ill, not more than 10 years younger than the deceased, or is a child, and would permits distributions to begin within one year of death and be spread over the life expectancy of the beneficiary. However, if that beneficiary dies or a child beneficiary turns 21, the general five-year-distribution rule would apply upon such occurrence.
The proposal regarding RMDs after the death of an IRA owner or employee generally would be effective for distributions with respect to IRA owners or employees who die after 2014. The proposals would not apply to certain qualified annuities that are binding annuity contracts in effect on the date of enactment and at all times thereafter. The proposal changing RMDs for 5% owners generally would become effective for employees becoming 5% owners with respect to plan years ending in calendar years beginning before, on, or after the date of enactment—except that the proposal would not result in a required beginning date earlier than April 1, 2015.
Various changes qualified plan changes
- Reduction in minimum age for allowable in-service distributions. Under the proposal, all defined-benefit plans as well as state and local government defined-contribution plans would be permitted to make in-service distributions beginning at age 59½. The proposal would be effective for distributions made after 2014.
- Under the proposal, the IRS would be required within one year of the date of enactment to change its guidance to allow employees taking hardship distributions to continue making contributions to the plan. The proposal would be effective for plan years beginning after 2014.
- Under the proposal, employees whose plan terminates or who separate from employment while they have plan loans outstanding would have until the due date for filing their tax return for that year to contribute the loan balance to an IRA in order to avoid the loan being taxed as a distribution. The proposal would apply to tax years beginning after 2014.
- Under the proposal, all defined-contribution plans (including 403(b) plans and governmental 457(b) plans) would be subject to the annual contribution limits currently applicable to 401(k) plans and would not have additional limits for different classes of employees at certain types of employers. The proposal would apply to plan years and tax years beginning after 2014.
- Early distributions from employer-sponsored retirement plans and IRAs are generally subject to an additional tax of 10%. This additional tax does not apply to early distributions from 457 plans sponsored by state and local governments. Under the proposal, participants in governmental 457 plans would be subject to the 10-percent additional tax on early distributions. The proposal would be effective for withdrawals after February 26, 2014.
Freeze inflation adjustments
Under the proposals, the inflation adjustments for the maximum benefit under a defined benefit plan, the maximum combined contribution by an employer and employee to a defined contribution plan, the maximum elective deferrals with respect to each type of SEP, SIMPLE IRA, and defined contribution plan (i.e., 401(k), 403(b), and 457(b)), and catch-up contributions would be suspended until 2024, at which time inflation indexing would recommence based off of the frozen level.
Nonqualified deferred compensation
Under the proposal, 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). The proposal would be effective for amounts attributable to services performed after 2014. The current-law rules would continue to apply to existing non-qualified deferred compensation arrangements until the last tax year beginning before 2023, when such arrangements would become subject to the proposal.
Modification of limitation on excessive employee remuneration
Under the proposal, the exceptions to the $1 million deduction limitation for commissions and performance-based compensation would be repealed. The proposal also would revise the definition of “covered employee” to include the CEO, the chief financial officer, and the three other highest paid employees, realigning the definition with current SEC disclosure rules.
Under the modified definition, once an employee qualifies as a covered person, the deduction limitation would apply for federal tax purposes to that person so long as the corporation pays remuneration to such person (or to any beneficiaries). The proposal would be effective for tax years beginning after 2014.
Excise tax on excess tax-exempt organization executive compensation
Under the proposal, a tax-exempt organization would be subject to a 25% excise tax on compensation in excess of $1 million paid to any of its five highest paid employees for the tax year. The excise tax would apply to all remuneration paid to a covered person for services, including cash and the cash value of all remuneration (including benefits) paid in a medium other than cash, except for payments to a tax-qualified retirement plan, and amounts that are excludable from the executive’s gross income.
Once an employee qualifies as a covered person, the excise tax would apply to compensation in excess of $1 million paid to that person so long as the organization pays him remuneration. The excise tax also would apply to excess parachute payments paid by the organization to such individuals. Under the proposal, an excess parachute payment generally would be a payment contingent on the employee’s separation from employment with an aggregate present value of three times the employee’s base compensation or more. The proposal would be effective for tax years beginning after 2014.
Denial of deduction as research expenditure for incentive stock options (ISOs)
Under the proposal, the rules with respect to incentive stock option plans and employee stock purchase plans would be clarified to deny a deduction under any provision of the Code for a transfer of stock to an individual under such plans. The proposal would be effective for stock transferred after February 26, 2014.
Under the proposal, no deduction would be allowed for entertainment, amusement or recreation activities, facilities or membership dues relating to such activities or other social purposes. In addition, no deduction would be allowed for transportation fringe benefits or for amenities provided to an employee that are primarily personal in nature and that involve property or services not directly related to the employer’s trade or business, except to the extent that such benefits are treated as taxable compensation to an employee (or includible in gross income of a recipient who is not an employee).
The 50% limitation under current law also would apply only to expenses for food or beverages and to qualifying business meals under the provision, with no deduction allowed for other entertainment expenses. Furthermore, no deduction would be allowed for reimbursed entertainment expenses paid as part of a reimbursement arrangement that involves a tax-indifferent party such as a foreign person or an entity exempt from tax. The proposal would be effective for amounts paid or incurred after 2014.
Repeal pension credit
Under the proposal, the credit for small employer pension plan start-up costs would be repealed. The proposal would be effective for costs paid or incurred after 2014 with respect to qualified employer plans first effective after such date.
Repeal employer-provided child care credit
Under the proposal, the credit for employer-provided child care would be repealed. The provision would be effective for tax years beginning after 2014.
Under the proposal, workers qualifying for a safe harbor would not be treated as an employee, and the service recipient would not be treated as the employer for any federal tax purpose. The safe harbor also would apply to three-party arrangements in which a payor other than the service recipient pays the worker. To qualify for the safe harbor, the worker would have to satisfy certain sales or service criteria and the worker and service recipient would be required to have a written agreement meeting specified requirements. In addition, the service recipient would withhold tax on the first $10,000 of payments made to the worker in a year at a rate of 5%. Amounts withheld under the safe harbor would be creditable by the worker against quarterly estimated-tax requirements.
In any situation when the IRS determines that the requirements of the safe harbor were not satisfied, the proposal generally would limit the IRS to reclassification of the worker as an employee and service provider as an employer on a prospective basis. To avoid retroactive reclassification, the worker or service provider would have to have satisfied the written agreement and the reporting and withholding requirements of the safe harbor and have had a reasonable basis for claiming that the safe harbor applied.
Indian general welfare benefits
Under the discussion draft, proposed IRS guidance specifically applying the general welfare exclusion to Indian tribes and payments received by tribal members, their spouses and children generally would be codified. The proposals also would require the IRS to establish a Tribal Advisory Committee to advise the IRS on matters relating to taxation of tribal members including training and education for IRS agents dealing with tribal members. Additionally, the proposals would provide the IRS with discretion to waive any interest and penalties under the Code for any tribe or tribal member with regard to the general welfare exclusion. The proposal codifying the IRS guidance concerning the general welfare exclusion would be effective for tax years for which the period of limitations is open as of the date of enactment, and taxpayers would have one additional year from the date of enactment to file for a refund with respect to any such open tax year.
For more information, contact a tax professional with KPMG’s Washington National Tax: