The U.S. tax code is always evolving, and the Tax Cuts and Jobs Act of 2017 made significant changes that will affect anyone who earns equity compensation. Below are a few highlights from this new law:
1. Lower individual tax rates. Individual tax brackets now range between 10% and 37%, with the top bracket applying to single filers who earn $500,000 or more and joint filers who earn $600,000 or more. The federal income tax withholding on equity compensation will be calculated by the third lowest rate, which is 22% for those with up to $1 million in compensation. The tax will be calculated based on the highest bracket (37%) for those with more than $1 million in compensation.
2. Changes to the alternative minimum tax (AMT) calculation. The AMT for exercising ISOs has not been repealed, but both exemption amounts and income phase-outs have been adjusted upwards, as follows:
- The 2018 AMT income exemption is now $70,300 for single filers and$109,400 for married joint filers
- The 2018 AMT income exemption phase-out starts at $500,000 for individuals and $1,000,000 for married couples.
These changes may encourage companies to offer more ISOs to their employees.
3. The Empowering Employees Through Stock Ownership Act. If you work for a private company, the Empowering Employees through Stock Ownership Act can offer you potential tax benefits. This provision will let employees in a privately held company defer taxes at option exercise or RSU vesting for up to five years, as long as the company's equity awards meet certain conditions. This is called the 83i election.
4. Repeal of the performance-based exception to the Section 162(m) limit on deductible compensation. Publicly traded companies can no longer deduct annual performance-based compensation of more than $1 million for C-level executives. This provision may encourage companies to offer a more diversified equity compensation plan to additional, lower-level employees.
These changes are quite complex, so be sure you understand the rules fully before making any changes. Be sure to consult with your tax advisor to see how these changes may affect your specific situation.