On December 20, 2019, the Internal Revenue Service (IRS) issued proposed regulations under Internal Revenue Code section 162(m). This section limits the annual compensation expense deduction available to publicly traded companies to $1 million for certain “covered employees.” Once finalized, the proposed regulations will implement the amendments made to Code section 162(m) by the Tax Cuts and Jobs Act (2017 Tax Act).
Background
Prior to the 2017 Tax Act, Code section 162(m) limited the annual compensation deduction expense available to publicly traded companies to $1 million per “covered employee” (i.e., the CEO and the next three highest paid employees, other than the CFO). Compensation in excess of $1 million was available for a deduction only if it met the exception requirements for certain commission and performance-based compensation paid to the “covered employee.”
2017 Tax Act Modification of 162(m) Deduction Limit
The 2017 Tax Act modified the Code section 162(m) deduction limit in several significant ways.
The new rules became effective for tax years beginning after Dec. 31, 2017. However, the 2017 Tax Act provided that compensation paid pursuant to a “written binding contract” in effect on Nov. 2, 2017, and not materially modified thereafter, is grandfathered and can continue to qualify for the performance-based compensation exception, assuming all other Code section 162(m) requirements are met.
IRS Notice 2018-68
In 2018, the IRS provided initial guidance regarding covered employees and the application of the grandfathering rules.
Proposed Regulations Summary
Following is a chart summarizing the key aspects of the proposed regulations:
Publicly Held Companies |
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Topic |
Summary |
Notes |
General Rule |
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Publicly Traded Subsidiaries |
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Foreign Private Issuers |
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Publicly Traded Partnerships (PTPs) |
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Affiliated Groups |
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Disregarded Entities |
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Q-Subs |
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Covered Employees |
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General Rule |
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Incongruent Tax v. Fiscal Year |
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Executive Officers Only |
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Separation from Service |
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Predecessor Companies |
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Disregarded Entities |
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Q-Subs |
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Grandfathering |
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General Rule |
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Negative Discretion |
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Clawbacks |
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Defined Benefit Plans |
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Severance |
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Loss of Grandfathering |
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Supplemental Agreements |
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Accelerated Vesting |
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Earnings |
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Contract Extensions |
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Right to Future Plan Participation |
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Accelerating Payment Timing |
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Deferring Grandfathered Payments |
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COLAs |
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Covered Compensation, Newly Public Companies & Effective Dates |
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Covered Compensation |
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Newly Public Companies |
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Effective Dates |
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For further information about the proposed regulations under Internal Revenue Code section 162(m), please contact one of the authors or any other member of McGuireWoods’ employee benefits team.