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Many states conform to the Internal Revenue Code, and the recent federal tax reform legislation will impact the states. In this article, Ryan LLC’s Mindy Mayo, Robert Kaelber, and Aaron Babb discuss how these changes will affect business payroll and employees.
By Mindy Mayo, Robert Kaelber, and Aaron Babb
Mindy Mayo is a principal with Ryan LLC in their San Jose, California office. Mindy is practice leader for Human Capital Tax, specializing in leading and advising organizations in the areas of human capital taxation, including financial and operational risk management, process improvement, and strategic management. Robert Kaelber is a director in Employment Tax with Ryan LLC in their Columbus, Ohio office. Aaron Babb is a manager in Employment Tax with Ryan LLC in their Cleveland, Ohio office.
Congress passed the Tax Cuts and Jobs Act (the “Act”), and it was signed into law in December of 2017. The changes to the Internal Revenue Code (IRC) will be substantial. The Act, in its official electronic version, available at https://www.congress.gov/bill/115th-congress/house-bill/1/text, is 185 pages long. There are payroll impacts that are important to note and are summarized below. The deductibility of several benefits normally provided to employees will also be impacted and may have a greater effect on employees and the way we do business.
Tax Rates and Withholding Calculations
Some of the most widely discussed changes included in the Act are the reductions in tax rates and the number of tax brackets (down to only seven in 2018). In addition, the Act increased the standard deduction to $24,000 for joint filers, $18,000 for head-of-household filers, and $12,000 for all others. However, the personal exemption is suspended until December 31, 2025. As a result, the withholding tables and resulting calculations will change, meaning your payroll system will need to be updated.
Notice 1036 has been provided by the Internal Revenue Service (IRS), and it provides the final set of guidelines for withholding in 2018. Those changes need to go into effect by February 15th.
Employee Achievement Awards
The definition of “tangible personal property” for purposes of deductible employee achievement awards under IRC §274 has changed, and provides some clarification of the rule. Under the new provision, “tangible personal property” cannot include “cash, cash equivalents, gift cards, gift coupons, or gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of such items pre-selected or pre-approved by the employer), or vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and any other similar items.” This provision takes effect for all tax periods after December 31, 2017. No sunset provision is currently applicable to this new rule.
Under prior law, qualified expenses reimbursed to an employee by the employer related to moving were excludable from the employee’s income. Any expenses that the employee could personally deduct under IRC §217 qualified for this exemption if paid by the employer. The Act repealed this exclusion in its entirety for all tax periods after December 31, 2017, though the removal of the exclusion is due to sunset on December 31, 2025. As a result, relocation payments are now subject to Social Security, Medicare, and Federal Unemployment Tax. We are now awaiting the state response to this addition to compensation. Currently, many states exclude relocation benefits from their definition of taxable wages. As a result, each state where you offer the benefit should be reviewed to determine the level of adherence to the Internal Revenue Code.
Companies should currently be reviewing their policies around the offering of relocation benefits. The fact that these benefits are subject to employment tax may result in employers limiting the amounts of relocation they are willing to pay due to the increased employment tax expense.
Fringe Benefits-Entertainment and Meals
The Act made substantial changes in the area of fringe benefits, altering the mechanics of several favored benefits. Most prominent, the Act effectively removed the deduction for any activity considered to be “entertainment, amusement, or recreation,” regardless of their relationship to a business function. Previously, these items could be deducted under IRC §274 if they were “associated with the active conduct of the taxpayer’s trade or business,” but now the deduction will not be permitted under any circumstances. Similarly, the Act removes the facility-related deduction mechanisms previously found in IRC §274. Taxpayers can no longer deduct membership dues for social, athletic, or sporting clubs or organizations, though they could previously deduct the portion of dues that they were able to substantiate as having a connection to the active conduct of their trade or business. And, by extension, taxpayers can no longer deduct expenses related to facilities used for entertainment, amusement, or recreation, regardless of the business connection.
Taxpayers will also see a change to meal-related fringe benefits. The 50% deduction for food and beverage expenses associated with operations (business meals during travel, for example) remains, but the Act expands the 50% limitation to any food and beverages provided to employees at an eating facility on the employer’s premise that meets both the criteria of a de minimis fringe and that is provided for the convenience of the employer. Previously, employers were able to deduct the full cost of meals meeting the latter criteria. The 50% eating facility deduction is available for all tax periods after December 31, 2017, but will sunset on December 31, 2025. At that time, no deduction will be allowed for eating facility-related expenses.
The changes to these fringe benefits will likely result in much discussion for the majority of companies. The inability to deduct entertainment expenses at the corporate level may result in changes to the way many companies do business. The change to meal-related fringe benefits will affect any company that has an in house cafeteria or that brings food in to its employees on a regular basis.
Family and Medical Leave Credit
Perhaps one of the most substantial tax changes related to employee benefits included in the Act is the creation of a (short term, for now) “family and medical leave credit,” which will appear in IRC §45S. This credit will allow eligible employers to claim a general business credit (under the terms and conditions of IRC §38) of 12.5% of any wages paid to qualifying employees when those employees are on family or medical leave, so long as the payment is made under a qualifying policy that pays at least 50% of the normal wages paid to such employee. That credit can increase by .25% (capped at 25%) for every 1% above the 50% provided in wages. The credit is also capped at 12 weeks’ worth of leave per employee.
To qualify, an employer must provide a written policy which provides all eligible employees at least two weeks of paid family and medical leave each year. This written plan must also permit, on a pro-rata basis, the same type of leave to any employee who is not considered full time. Qualifying employees are any employee who (1) meets the definition found in the Fair Labor Standards Act (FLSA), Section 3(e); (2) has been employed with that employer for at least one year; and (3) was not paid over 60% of the compensation threshold for highly compensated employees.
Note that the leave must meet the requirements for “family and medical leave” found in the Family and Medical Leave Act (FMLA) Sections 102(a)(1)(a)-(e) or 102(a)(3). Any employer-provided leave that is categorized as vacation, personal, or other medical or sick leave will not qualify towards this credit. Also, any benefits/leave time that is required under state or local law must be excluded from the credit; only benefits above what is required by law may be applied.
This credit will be a large windfall for employers with qualifying leave plans already in place, but it will also be a good opportunity for employers who may not meet the requirements for the credit to review their leave policies and determine what changes could be made to qualify, and whether those changes will be beneficial to their enterprise. But act quickly, like most provisions of the Act, the credit has a sunset clause attached and will only be available for wages paid in 2018 and 2019.
The Act also provided some new procedures for equity compensation. Under the Act, qualified employees can defer attribution of qualified stock transactions from the employee’s income. To be effective, the election must occur no more than 30 days after the earliest of two events: (1) vesting or (2) when the employee’s right to the stock becomes transferable. The deferral is made in a manner similar to an election under IRC §83(b). This new deferral procedure includes limitations on the employees and types of stock transactions that qualify, when the income must subsequently be recognized, and also requires technical adherence to strict notice, withholding, and reporting requirements. Failing to comply with the notice requirements, for example, can carry a penalty of $100 for each failure to a maximum of $50,000, so you should work with your stock plan administrators and payroll tax professionals to establish procedures for properly implementing this new deferral mechanism.
Other 2018 Updates
Although not part of the Act, the following are some additional 2018 updates for consideration:
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