Because of the pending fiscal cliff and the possibility of higher tax rates coming in 2013, we have been asked if private company employers should accelerate payments of incentive compensation into 2012, rather than pay them in 2013. This strategy may sound tempting to executives given all of the headlines of the fiscal cliff and potentially higher tax rates on high-wage earners. Still, a lot can happen between now and December 31st. To determine the appropriate tax planning strategy, employers should take the following steps.
- Have a Discussion With Key Executives. Your key executives are probably concerned about the impact of anticipated tax increases on their personal income, and they may be interested in accelerating income into 2012. Strategies worth considering include the following:
- Accelerating into 2012 payments of annual bonus and other incentive amounts that otherwise would be paid by March 15, 2013.
- Exercising stock options and stock appreciation rights in 2012 (and accelerating vesting of these amounts to the extent necessary to permit such exercises).
- Accelerating vesting of restricted stock.
- Accelerating vesting of restricted stock units and phantom stock that are payable on the vesting date.
- Consider Plan Documentation and Code Section 409A Challenges. If executives are interested in pursuing any of the previously described strategies, employers should review their plan documents and agreements to see if they allow acceleration of vesting and payment of incentive compensation, or whether these arrangements need amendments. Employers also should be mindful of Code Section 409A. Most bonus arrangements, stock options, and stock appreciation rights are exempt from Code Section 409A, which means that accelerating vesting and payment of these amounts ordinarily would not cause the executives to incur any tax penalties. Restricted stock also is exempt from Code Section 409A. Restricted stock units and phantom stock arrangements that pay in a future year after the vesting date (e.g., that pay at termination of service), however, are subject to Code Section 409A. Also, if executives made elections to defer bonus payments, those elections are subject to Code Section 409A. Any acceleration of such amounts could subject the executives to an additional 20% tax on these amounts.
- Determine When to Act. If an employer concludes that neither Code Section 409A nor the documentation for the incentive arrangements pose significant hurdles, the employer needs to consider when to act. The issue is that nobody knows what a fiscal cliff deal will look like. Although it seems unlikely, one possibility is that a deal eliminates tax deductions but does not increase tax rates. Under that scenario, accelerating payment into 2012 would give executives a larger than normal tax bill in 2012 (perhaps to the point of pushing them into a higher bracket) without providing much savings in 2013. Alternatively, Congress and the President may raise rates, or they may allow current rates to increase and work on a deal next year. We do know that under health care reform, the Medicare tax will increase from 1.45% to 2.35% on wages that exceed $200,000 for single employees and $250,000 for married employees who file jointly. The current payroll tax holiday probably will expire too. So, while taxes on executives probably will increase in 2013, it still makes sense to delay actual payment until we have a better idea of what taxes will be next year. If it turns out that accelerating payment is the best choice for executives, employers should be ready to pay those amounts by Monday, December 31st.
- Public Company Employers Probably Should Not Accelerate Payments. Although we have focused on private company employers, public company employers also face the same issues we have described. Public company employers also must worry about Code Section 162(m) and securities law disclosures. In particular, public companies will need to determine whether acceleration of payment should be disclosed to shareholders and whether the bonus payments can satisfy the “performance-based” requirements despite being paid before the end of the year. While we do not want to dismiss this strategy outright, these additional hurdles probably do not make accelerating incentive payment a viable strategy for public company employers.
Conclusion. In short, accelerating vesting and payment of incentive pay into 2012 could be a serious tax planning opportunity for executives of private companies. Employers will want to make sure their incentive arrangements provide the flexibility to allow for such accelerations, and they will want to make sure that such accelerations will not create any problems under Code Section 409A. While it is important for employers to consider these steps now, they should wait to get a better understanding of what a possible fiscal cliff deal will look like and then talk to their executives to make sure that accelerating payment is the right strategy. We normally do not recommend hurry-up-and-wait approaches, but in this case, it probably is the only option.