Section 162(m) $1 million Compensation Deduction Limitation: Are you covered?

Tax Reform

WHAT DO YOU NEED TO KNOW?

IRS Notice 2018-68 gives guidance on how to apply the modifications made by the 2017 Tax Cuts and Jobs Act (TCJA) to IRC Section 162(m), which states that compensation of more than $1 million paid to “covered employees” of publicly held corporations is nondeductible.

Particularly, the TCJA amended Section 162(m) in three main parts. This includes:

1. Expanding the definition of “publicly held corporation”

Entities that would not have previously been subject to Section 162(m) are now included

2. Broadening the definition of “covered employee”

CFOs are included; additionally, individuals treated as covered employees for any prior year will be treated as
covered employees for all subsequent years (i.e. “once a covered employee, always a covered employee”)

3. Eliminating the “performance-based” compensation exception

The deduction limitation is now applied to all compensation exceeding $1 million, regardless of classification

The amendments are generally applicable to taxable years starting after December 31, 2017. However, the amendments are not applicable to compensation that is payable pursuant to a legally binding contract in effect as of November 2, 2017, so long as the contract is not materially modified after this date; this transition relief is known as the “grandfathering rule.”

Qualified Business Income (QBI)
W-2 Wages
Qualified Property Basis; and
Overall Taxable Income

HOW WILL IT AFFECT YOU?

The notice will affect individuals within a “publicly held corporation” who fall under the newly expanded definition of a “covered employee.”

To be considered a “covered employee,” an individual must:

Have served as CEO or CFO under a publicly held corporation during the year; or

Be among the three most highly compensated officers for the taxable year

The “grandfathering rule” is employed in a nuanced manner, depending on the circumstances, but is generally narrowly construed.

The “grandfathering rule” may be applicable to:

Pre-existing CFO Employment Agreements – unless materially modified
Prior Compensation Deferrals under non-qualified plans
Prior Performance-Based Equity Awards (assuming no enforceable negative discretion)

WHAT CAN A&M Tax DO FOR YOU?

Although IRS Notice 2018-68 brings some clarity to the “grandfathering rule” of Section 162(m) as modified by the TCJA, applying its provisions can be complicated and tedious. As these regulations further develop, our Alvarez & Marsal Taxand team is uniquely positioned to determine which arrangements may still permit a compensation deduction in excess of $1 million for a covered employee under the rules as in effect prior to the enactment of the TCJA.

To learn more about our services, visit: https://www.alvarezandmarsal.com/expertise/tax