Guest Article

(From the November 10, 2008 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Tax Policy Related to Compensation and Benefits in the New World

President-elect Obama's Call for Change focuses on the likely tax agenda for 2009 and 2010, which may unfold in two distinct pieces. The first could be tax cuts focused on economic recovery and other stimulus actions meant to address the current economic downturn. The second could be a package of tax proposals to address the longer-term issues that were raised in the campaign.

Large pieces of Obama's agenda will enjoy bipartisan support while other parts may encounter bipartisan opposition. What is clear is that neither the President-elect nor Congress plans to dramatically increase the total tax collections of the federal government.

Moreover, the current economic climate will make tax increases and spending cuts in the near term more difficult and, perhaps, less advisable. The new administration and Congress will hesitate in taking any action that can be seen as further suppressing economic activity. In addition, they may wish to undertake new spending to stimulate the economy and will find that safety-net spending by the federal government for unemployment and other benefits rises automatically as the economy weakens.

IRA's and 401(k)s -- With respect to IRAs and 401(k)s, Obama would permit penalty-free hardship withdrawals from retirement accounts in 2008 and 2009 and suspend the mandatory distribution rules for those who have reached age 70½ (or exempt those distributions from tax for account holders that elect to take them). He also would accelerate the effective date of a number of his basic tax proposals.

Executive Compensation -- During the campaign, Obama indicated that he would examine the tax treatment of executive compensation, but offered little detail beyond closing loopholes in the "corporate tax deductibility of CEO pay." Proposals are possible in three areas. First, the leadership of the Senate Finance Committee has proposed a $1 million limitation on nonqualified deferred compensation. Second, continuing the trend of recently enacted restrictions on executive compensation for organizations participating in the government's financial bailout program, we may see repeal of the performance-based pay exception for the section 162(m) deduction limitation rules and an expansion of the individuals whose compensation is subject to the rules. Third, the Emergency Economic Stabilization Act (EESA) provides for more governance rules with respect to executives in companies participating in the recovery plan that would prohibit certain golden parachute payments, require recovery of incentive compensation that is paid based on information that later proves to be materially inaccurate, prevent employment contracts from including any payment on account of involuntary termination, bankruptcy, or insolvency, and require compensation committee certification that incentive compensation does not encourage unnecessary and excessive risks. These kinds of limitations could be woven into a revision of current-law limitations.

Health Care Reform -- During the campaign, Obama called for far-reaching health care reform. As part of financing his reform plan, he would require large employers that do not offer or make a meaningful contribution to the cost of health care for their employees to contribute a percentage of payroll toward the costs of a National Health Insurance Exchange. He has not indicated what percentage of payroll would be required under this proposal or specified what amount would constitute a "meaningful contribution" to the cost of health care. Small businesses would be exempt from this requirement, and would receive a new Small Business Health Tax Credit intended to reduce their health care costs.

Private Equity -- Obama supports legislation that would increase taxes on certain private equity and hedge fund entities. Specifically, he has stated that he would propose legislation to tax income from carried interests as earned income subject to ordinary rates and self-employment taxes. Such legislation was approved by the House twice in the past two years. Obama also supports legislation that would tax publicly traded partnerships engaged in investment-advisor services or related asset-management services as corporations.

Long-Term Social Security Payroll Tax Increase -- Although the need for Social Security reform is often discussed, long-term solutions are not apparent. After 2017, Social Security expenditures are expected to exceed employer and employee payroll tax collections. Add to this the fact that by 2025, 31 percent of U.S. adults will be retirement age and it becomes clear that preservation of the Social Security trust fund surplus and future solvency of the system are at risk. To address these long-term needs, Obama has said that he would propose an additional payroll tax to take effect 10 years or more in the future. This tax would be at a rate of between 2 and 4 percent (split between employer and employee) and would apply to income above $250,000. We believe that action on any such proposal will necessarily be delayed until the administration and Congress are prepared to engage in a broader discussion of what to do about entitlement spending.

(Note: This story was excerpted from Deloitte's "Tax Policy Decisions Ahead: President-elect Obama's Call for Change," which is available on the Deloitte Web site at http://public.deloitte.com/media/0163/us_tax_decisionsaheadobama110508.pdf.)

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2008, Deloitte.