Tax Bill Proposal Does Not Affect ESOPs; Impact on Stock Option Taxation Unclear

The Republican tax proposal released on November 1 does not contain provisions that will directly affect ESOPs. There had been some concern that the plan would make changes to retirement plan law, but no significant modifications were proposed.

The plain language of the bill appears to contain a surprising change to equity plan taxation. It would change current tax rules for restricted stock, stock options, and stock appreciation rights so that the grants are taxed on vesting, not on exercise or, in the case of qualifying dispositions of incentive stock options, upon the sale of the shares. Just the day before, Kevin McCarthy (R-CA) had an op-ed published in the Financial Times saying the bill would incorporate the language of the Empowering Employee Ownership Act (which has passed the House already by a wide margin) that would have delayed taxation on unexercised options in closely held companies for up to seven years after termination of employment. But while the language seems clear enough, stating that "the rights of a person to compensation shall be treated as subject to a substantial risk of forfeiture only if such person's rights to such compensation are conditioned upon the future performance of substantial services by any person," the National Venture Capital Association (NVCA) said that the bill provides that unexercised options are not taxable until they are liquid. It may be that the press release was issued on the assumption that McCarthy's promise would actually show up in the bill—or it could be a drafting error. According to a spokesperson for the NVCA the NCEO contacted, the NVCA still expects that the language of the Empowering Employee Ownership Act will be in the chairman's mark (the legislative draft introduced by the chair of a committee or subcommittee) that comes out after the Ways and Means Committee marks it up.

The bill does contain two provisions that make relatively minor changes in rules that may be of interest to ESOP companies and companies providing equity compensation:

• Change in definition of normal retirement age for in-service distributions: Under current rules, there is a safe harbor presumption that if an employee reaches age 62 and is still working, that can be deemed normal retirement age, and the employer can begin in-service distributions without special tax consequences. The bill would change this to 59½.
• Defined benefit plan aggregate testing: The law makes liberalizing changes to how companies with defined benefit plans can be aggregated with certain defined contribution plans, including ESOPs, for qualifying under antidiscrimination rules.

Of course, it expected that changes will be made to the tax bill, so these provisions are just the starting point.