Tax Act May Affect Retirement Plans

The Tax Cuts and Job Act does not change legislation for employee stock ownership plans (ESOPs), but it could have some indirect effect in regard to how they are taxed, according to an “Employee Ownership Update,” written by Loren Rogers, executive director of the National Center for Employee Ownership.

The tax bill limits net interest deductions for business to 30% of earnings before interest, taxes, depreciation and amortization (EBITDA) for four years, but, starting in 2022, it will exclude deductions on earnings before depreciation and amortization. Or in other words, Rogers says, “businesses will subtract depreciation and amortization from their earnings before calculating their maximum deductible interest payments.”

New leveraged ESOPs that borrow a large amount relative to their EBITDA, Rogers says, “may find that their deductible expenses will be lower, and, therefore, their taxable income may be higher under this change.” However, 100% ESOP-owned corporations will not be affected because they pay no tax, he says.

“Many questions remain [as to] the impact of this change,” Rogers says. “Importantly, it is not yet clear whether the limit on deductibility of interest will apply to loans made after the bill goes into effect or if it will apply retroactively. It is also unclear what impact the bill will have on alternative structures such as replacing simple interest with warrants or payment-in-kind interest.”

The tax act does not fundamentally change the tax breaks retirement plan participants receive, according to a law alert issued by The Wagner Law Group.

Yet, it does make some changes to Employee Retirement Income Security Act (ERISA) plans, including nonqualified deferred compensation (NQDC) plans and 529 college savings plans. The act will continue to allow taxpayers to recharacterize contributions made to a Roth individual retirement account (IRA) as contributions to a traditional IRA, as long as this is done before the due date of the taxpayer’s income tax return, including any extension. Importantly, this will not apply to the reverse situation, where an investor would take traditional IRA contributions and then recharacterize them as Roth.

Currently, if an employee has taken a loan from his retirement plan and has an outstanding balance on termination from his job, he has up to 60 days to roll over the outstanding loan balance to an IRA to avoid having the loans treated as taxable distributions. The tax bill extends this rollover period to the due date for filing one’s tax return.

With respect to nonqualified deferred compensation (NQDC) plans, the bill modifies the definition of a “covered employee” at a publicly traded company. A covered employee includes the CEO and the chief financial officer (CFO), as well as the next three highly compensated employees, during the tax year.

College savings plans are now amended to permit 529 account owners to take a $10,000 distribution each year and apply it not just to college expenses but also to public, private or religious elementary or secondary schools.