Newsletter Vol. 1, No. 1 September 1997

The just enacted Taxpayer Relief Act of 1997 (TRA 97) contains many provisions relevant to executive compensation and benefits administrators. Most significant are the changes in the capital gains rules and the repeal of the excess distributioni excess accumulation taxes. Other provisions are noted elsewhere in this newsletter.

The new 20% rate on capital gain property held for at least 18 months, and the new 18% rate on five-year property acquired after 2000 will prompt reexamination of a number of executive compensation practices that developed while the tax rates applicable to compensation and long-term capital gain were the same and continued thereafter while the spread between the rates was smaller. One point to watch will be how, for employee stock option purposes, Treasury interprets the provision under which the option period counts for purposes of the five-year holding rule. As a result, restricted stock, with shorter vesting periods, will become more desirable because post-vesting appreciation will be taxed at the new lower rates. Stock option holders will be prompted to exercise earlier to qualify more post-exercise appreciation for the new lower rates, and the employer's associated ihcome tax deduction may be lower as options are exercised earlier. Incentive stock options issued under 422 will be more desireable because all appreciation is capital gain -- but subject to the alternative minimum tax. On the other hand, deferred cash and stock bonuses and phantom stock awards will be less desirable because all pre-payment appreciation is compensation income.

The repeal of the excise taxes on excess distributions and excess accumulations relieves holders of substantial IRAs and qualified plan benefits of complex planning. However, minimum distributions must still commence at age 70 1/2.

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