Pension & Benefits News IRS proposed regs address rules related to deduction limit for compensation in excess of $1,000,000
Friday, January 24, 2020

IRS proposed regs address rules related to deduction limit for compensation in excess of $1,000,000

By Pension and Benefits Editorial Staff

IRS proposed regulations provide guidance related to the limitation on the deduction for employee compensation in excess of $1 million under Code Sec. 162(m). The proposed regulations implement the amendments made to Code Sec. 162(m) by the Tax Cuts and Jobs Act (P.L. 115-97, TCJA).

These regulations are generally proposed to apply to compensation that is otherwise deductible for taxable years beginning on or after the date of publication of the final regulations in the Federal Register. The IRS provides that taxpayers may choose to rely on these proposed regulations until the applicability date of the final regulations, provided that taxpayers apply these proposed regulations consistently and in their entirety. In addition, taxpayers may no longer rely on IRS Notice 2018-68 for taxable years ending on or after December 20, 2019, but instead may rely on these proposed regulations for those taxable years.

Background on limitation on excessive employee compensation. The TCJA modified the definitions of “covered employee,” “compensation,” and “publicly held corporation” for purposes of the limitation on the deduction for excessive employee compensation paid by publicly held corporations.

Publicly held corporations. The TCJA expanded the definition of publicly held corporation to include: (1) corporations with any class of securities and (2) corporations that are required to file reports under section 15(d) of the Exchange Act. The proposed regulations similarly define a publicly held corporation. Specifically, the proposed regulations state that a corporation is publicly held if, as of the last day of its tax year, its securities are required to be registered under section 12 or is required to file reports under section 15(d).

Covered employees. Under the amended law, a covered employee is the principal executive officer, the principal financial officer, or one of the three other highest compensated executives. The IRS clarifies that there is no requirement that an employee must be an executive officer at the end of the tax year to be a covered employee. The definition applies regardless of whether the executive officer is serving at the end of the publicly held corporation’s tax year. Furthermore, the definition applies regardless of whether the executive officer’s compensation is subject to disclosure for the last completed fiscal year under the applicable SEC rules.

Applicable employee compensation. The proposed regulations define compensation as the aggregate amount allowable as a deduction for services performed by a covered employee, without regard for Code Sec. 162(m) and whether or not the services were performed during the taxable year. The proposed regulations also clarify that compensation includes an amount that is includible in the income of, or paid to, a person other than the covered employee, including after the death of the covered employee.

Privately held corporations that become publicly held. These proposed regulations provide that, in instances where a privately held corporation becomes public, Code Sec. 162(m) applies to the deduction for any compensation that is otherwise deductible for the tax year ending on or after the date that the corporation becomes a publicly held corporation. In addition, the proposed regulations provide that a corporation is considered to become publicly held on the date that its registration statement becomes effective either under the Securities Act or the Exchange Act.

Grandfather rules. The amendments made by the TCJA to Code Sec. 162(m) do not apply to any compensation paid under a written binding contract that is effect on November 2, 2017 and is not materially modified after that date. In order for the IRS to consider a contract binding the publicly held company must be obligated under applicable law to pay the compensation if the employee performs services or satisfies requirements in the contract. Thus, the amendments to Code Sec. 162(m) apply to any amount of compensation that exceeds the amount required under applicable law to be paid to an executive under a binding contract.

Material modifications. Under the proposed regulations, material modifications include an increase the amount of compensation payable to the employee. If a contract is modified to accelerate the payment of compensation, it is a material modification unless the amount of compensation paid is discounted to reasonably reflect the time value of money. Material modifications may also include modifications that defer compensation under certain circumstances. In addition, supplemental contracts or agreements may materially modify the existing contract.

Source: 84 FR 70356.

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