Tax Reform: How It Affects Pilots’ Employee Fringe Benefits
By Dan White, Senior Benefits Attorney, ALPA Retirement & Insurance Department
The Tax Cuts and Jobs Act (TCJA) was signed into law by President Trump on Dec. 22, 2017. It makes sweeping changes to the Internal Revenue Code in general and substantially modifies the taxation of employee fringe benefits, which is expected to significantly impact pilots. Fortunately, the TCJA made only modest changes to retirement benefits. Generally, most provisions of the TCJA took effect Jan. 1, 2018, and apply to income earned beginning in the 2018 taxable year. Many of these changes sunset after Dec. 31, 2025, unless Congress passes an extension.
Congress subsequently passed the Bipartisan Budget Act (BBA), which President Trump signed on Feb. 9, 2018. This law features several tax provisions that had previously been dropped from the TCJA. This article summarizes the tax reform changes made to employee fringe benefits by the TCJA and the BBA and does not discuss changes made to individual income tax rates, college savings incentives, estate planning, or corporate taxes. ALPA members should consult a tax professional to understand how changes made by the new tax law will affect them.
Business expenses
Prior to 2018, pilots who itemized their deductions could deduct ordinary and necessary business expenses from their federal taxes. Ordinary and necessary business expenses for pilots include unreimbursed travel costs, union dues, pilot uniforms, and medical examinations required by the FAA. The TCJA eliminates itemized deductions for ordinary and necessary business expenses paid or incurred by a taxpayer as of Jan. 1, 2018. As a result, pilots who itemize their deductions are no longer able to deduct these expenses when filing their federal taxes. This increases the tax burden for many pilots who are required to pay these costs themselves.
Per diem
Prior to the TCJA, per diem reimbursements paid to pilots by their employer that did not exceed the federal per diem rate were not treated as taxable income. In addition, pilots who itemized their deductions could deduct their actual business travel expenses that were in excess of any per diem reimbursements they received. The TCJA does not change the exclusion of per diem reimbursements from taxable income. Therefore, per diem reimbursements paid by the employer up to the federal rate are still not considered taxable income. However, as of Jan. 1, 2018, pilots are no longer able to deduct the difference between the per diem reimbursement amount and actual business travel expenses incurred.
Moving expenses
Before 2018, employer reimbursements for moving expenses were excluded from taxable income, and unreimbursed job-related moving expenses were deductible. Under the TCJA, both the exclusion for moving expense reimbursements and the deduction for unreimbursed moving expenses are eliminated. Some pilot contracts provide that the employer pay for moving expenses, and as of 2018 these payments are treated as taxable income. Pilots who incur work-related moving expenses beginning in 2018 that are not reimbursed by the employer are no longer able to deduct these expenses from their federal taxes.
Retirement plan loans
When a pilot takes a distribution from a retirement plan, the distribution is treated as taxable income (and may be subject to early withdrawal penalties) unless it is rolled over to an IRA or another eligible retirement plan within 60 days. This rule creates issues for a pilot who terminates employment with an outstanding 401(k) loan balance.
Most 401(k) plans require the pilot to repay the outstanding loan balance upon termination of employment. If the pilot fails to do so, the unpaid balance is treated as a distribution. Prior to tax reform, the distribution of the unpaid balance would be treated as taxable income (potentially also triggering early withdrawal penalties) unless the pilot rolled over the amount of the unpaid balance to an IRA or other eligible retirement plan within 60 days, as with other distributions.
The TCJA allows employees who terminate employment with an outstanding 401(k) loan to avoid taxation on the outstanding loan balance by rolling over the amount of the loan to an IRA or other eligible retirement plan on or before the due date for filing tax returns (including extensions). This change provides relief to pilots who terminate employment with an outstanding 401(k) loan balance and are required under the terms of the plan to repay the outstanding balance within the 60-day timeframe.
Retirement plan hardship withdrawals
The Internal Revenue Code allows 401(k) plans to provide “hardship withdrawals” under which plan participants can take early distributions to address an immediate and heavy financial need. Prior to tax reform, a pilot was generally required to take all available plan loans before taking a hardship withdrawal. The pilot was also restricted from making salary deferral contributions for six months after the hardship withdrawal. In addition, certain types of plan contributions could not be used for hardship withdrawals.
The BBA now allows plans to ease hardship withdrawal rules, beginning Jan. 1, 2019. Pilots will no longer be required to take plan loans before receiving a hardship withdrawal. Additionally, the six-month prohibition on salary deferral contributions following a hardship withdrawal is eliminated. The new law allows qualified nonelective contributions, qualified matching contributions, and profit-sharing contributions to be included in a hardship withdrawal. These new rules will make it easier for 401(k) plans to make hardship withdrawals available to pilots.
Disaster relief for retirement plan distributions
In general, 401(k) plan distributions that are not rolled over are taxed in the year that the distribution is taken. In addition, distributions taken before age 59½ that are not rolled over are generally subject to an additional 10 percent early withdrawal penalty. Last year, Congress approved disaster relief legislation, including retirement tax relief, for the victims of Hurricanes Harvey, Irma, and Maria, necessitating a need to extend the assistance to the California wildfire victims and victims of disasters that occurred in 2016. The TCJA permits an early withdrawal from a 401(k) plan of up to $100,000 without penalty if (1) the taxpayer lived in a presidentially declared disaster area in 2016, (2) the taxpayer sustained an economic loss due to the declared disaster, and (3) the withdrawal was taken in 2016 or 2017. The BBA allows an early withdrawal of up to $100,000 without penalty if (1) the taxpayer lived in an area affected by the 2017 California wildfires, (2) the taxpayer sustained an economic loss due to the wildfires, and (3) the withdrawal was taken between Oct. 8 and Dec. 31, 2017.
These distributions are taxed as ordinary income over a three-year period. Pilots who lived in a disaster area in 2016 or were affected by the California wildfires in 2017 and were forced to take a 401(k) distribution due to the impact of the disaster should be able to take advantage of this relief. A list of presidentially declared disaster areas for each year can be found on the FEMA website.
IRS tax levies
Prior to tax reform, if a pilot withdrew money from a 401(k) account to pay an IRS tax levy, and the IRS later returned the amount to the pilot, that money could not be recontributed to the plan. Under the BBA, the pilot may now recontribute the returned money, including any related interest. This new rule became effective Jan. 1, 2018.
Repeal of individual mandate
Beginning in 2019, the TCJA repeals the individual mandate under the Affordable Care Act, which requires U.S. citizens and Green Card holders to maintain medical coverage. This provision will not directly affect pilots, who are covered under collectively bargained medical plans. However, without the individual mandate, many young and healthy individuals may exit the medical risk pool. This will likely drive up the cost of medical coverage for everyone else, including airlines.
Retirement savings and health coverage
The new laws do not make major changes to retirement savings. The favorable tax treatment and contribution limits for 401(k)s, IRAs, and other retirement savings accounts remain intact. The rules for health savings accounts and flexible spending accounts also remain intact. Employer-provided health-care benefits are still treated as nontaxable income.
However, the TCJA does end Roth IRA recharacterizations beginning with the 2018 taxable year, although 2017 recharacterizations will continue to be permitted until Oct. 15, 2018. A recharacterization allows a taxpayer to “undo” or “reverse” a rollover or conversion to a Roth IRA.
Congress is expected to pass a technical corrections bill that could potentially modify some of the provisions that impact pilots. ALPA’s Retirement & Insurance and Government Affairs Departments will be monitoring this issue for any pertinent developments.
This article contains information related to the 2018 tax year. For help filing your 2017 taxes, read “Preparing Your 2017 Taxes.”
