Executive compensation considerations in the wake of major tax reform

Leo Vartorella - Print  | 

President Donald Trump signed the Tax Cuts and Jobs Act into law Dec. 22, 2017. This law not only overhauled the tax code, but included key provisions affecting executive compensation for tax-exempt organizations.

During a recent webinar hosted by Becker's Hospital Review, Willis Towers Watson experts, Betsy Field, Health Care Industry Total and Rewards Leader; Susan Sulisz, Managing Director, Executive Compensation; and Paul Weber, Actuary, Retirement; shared insights to help eligible organizations better understand the changes surrounding executive compensation and develop strategies to ensure the optimal use of resources.

Under the newly signed legislation, tax-exempt entities such as qualifying hospitals and health systems must pay a 21 percent excise tax on any remuneration exceeding $1 million to all covered employees after Dec. 31, 2017. A "covered employee" is a current or former employee who was among the five highest compensated employees in a tax year beginning after 2016. This means organizations could have up to 10 covered employees in 2018 if the top five earners for that year are completely different than 2017.

Covered employees are covered forever, and a former covered employee who receives post-termination compensation in excess of $1 million per year is subject to excise taxes. These taxes are paid by the organization, which would still be subject to potential excise taxes for terminated covered employees as long as they are still receiving taxable pay.  It is essential for providers to understand that ”covered employees” must be identified at each entity within a given organization – the entities cannot be aggregated for this purpose. Organizations that filed multiple 990 tax forms must pay excise taxes on any covered employees with pay in excess of $1 million for each separate entity. 

Remuneration subject to the excise tax includes all compensation an employee received during a calendar year, including pay from affiliated or related organizations. However, Ms. Field noted qualified retirement payouts are excluded and there is an important exception for providers to consider.

"The excise tax excludes any remuneration paid from qualified retirement plans and any payments to licensed medical professionals for the performance of medical services," Ms. Field said. "If you have a chief medical officer who's a physician but they're receiving administrative pay as opposed to pay for medical services, that remuneration would be subject to the excise tax. However, if that individual receives half their compensation by actually providing medical services, that portion of the pay would not be included."

Ms. Sulisz clarified that severance pay can also trigger the excise tax if the severance is greater than or equal to three times the “base amount”. The “base amount” is the average W2 pay for the employee's last five taxable years at the company. However, the tax is applied to all severance amounts that exceed one times the base amount.

Ms. Sulisz said organizations must do important front-end work to prepare for these changes, including identifying covered employees and rethinking how their pay structure may trigger this new tax, perhaps considering how a lump-sum payment that could trigger the $1 million tax could be split across more than one tax year to allow an additional amount to be exempt from the tax.

"Organizations need to come to terms with how to balance this new cost of doing business and the public relations issues it might bring, with the continued need to attract and retain executive talent," Ms. Sulisz said. "We do not expect any organizations will be capping executive pay or reduce pay in order to avoid the excise tax, but you can already start identifying covered employees in 2018 if someone new has moved into the top five earners through promotion, SERP distribution or other means, and set up a mechanism to track these employees — because once covered, always covered, even if terminated."

Mr. Weber added that while a stable base salary of under $1 million may not trigger an excise tax on its own, there can be material tax implications for lump sum-vesting events which create a spike in taxable income during one tax year.

"Organizations could mitigate this excise tax event by accelerating vesting of lump-sum payments over a number of years. This spreads payments into taxable income and results in pay levels that do not trigger excise taxes," Mr. Weber said. "Accelerating a SERP payment has other implications, though, and organizations may want to have some handcuff associated with the payment to ensure employees stay on. Instead, vesting and payment could also be deferred.

Organizations should expect a public reaction to these new taxes and should proactively address issues by defining and implementing a communication strategy and managing the messaging about the organization’s pay strategy.

Moving forward, hospitals and health systems must work actively to understand the potential impact of these taxes, review existing arrangements, consider changes for their executive compensation plans and develop an appropriate communications plan.

Click here to learn more about navigating the changes associated with the new tax reform landscape.

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