Soft caps.

Yesterday we described how TRA 2014 would lump taxable with tax-exempt employers for deferred compensation limits. Today, the reverse is true.

Currently, certain types of publicly traded employers may deduct up to $1,000,000 of compensation paid to their CEOs and other officers. Tax-exempt employers have only "reasonableness" limits on executive compensation, and the prohibition of private inurement for certain organizations (e.g., hospitals). A deduction cap wouldn't make sense for them, because they are tax-exempt.

But TRA 2014 would provide a new incentive for tax-exempt employers to limit executive compensation. It adds an excise tax of 25% on compensation (including benefits) over $1,000,000 to any of the employers' five highest paid executives each tax year. This tax would be paid by the employer.

Paying an executive more than $1,000,000 will be expensive. The mechanisms vary between taxable and tax-exempt employers, but the overall result — a disincentive to pay more than $1,000,000 in compensation — would be the same.

Welcome to our world.

Under the recently published draft of the Tax Reform Act of 2014 (“TRA 2014”), taxable employers would learn first hand what their tax-exempt siblings have to deal with when paying their executives. Tax-exempt employers have long operated under §457(f) of the tax code, which taxes deferred compensation as soon there is no substantial risk of forfeiture. In 2005, §409A brought some of these regulations to taxable employers, along with some stiff penalties for non-compliance.

But TRA 2014 includes a new §409B that would lump taxable and tax-exempt employers together under rules similar to §457(f). Any non-qualified deferred compensation would be taxable as soon as it is not subject to a substantial risk of forfeiture. Section 409A — and its penalties — would be repealed, and §457(f) would be negated.

While TRA 2014 is only a draft with an uncertain future, it gives us an idea of what tax reform might look like, and how the deferred compensation landscape might change.