IRS Proposes 162(m) Regulations Limiting Public Company Deductions for Executive Compensation Over $1 Million

IRS Proposes 162(m) Regulations Limiting Public Company Deductions for Executive Compensation Over $1 Million

On December 20, 2019, the IRS published proposed regulations implementing changes made to Internal Revenue Code Section 162(m) by the Tax Cuts and Jobs Act (TCJA). The new rules clearly set the tone that the IRS will broadly apply the Section 162(m) executive compensation deduction disallowance. The new rules generally follow the interim guidance but provide, among other things, new information for privately held companies that are going public, certain foreign companies, publicly traded companies with Section 409A nonqualified deferred comp programs fitting certain design criteria for earnings accruals, and publicly traded corporations that pay certain executives through partnerships, subsidiaries or affiliates.



In general, Section 162(m) eliminates publicly traded employers’ deduction for executive compensation in excess of $1 million. However, since its enactment in 1993, Section 162(m) provided an exception for performance-based compensation, which TCJA repealed. TCJA also expanded the scope of Section 162(m) by amending the definition of “covered employee” to include principal executive officers, principal financial officers and the three highest paid executive officers (even if the federal securities laws do not require disclosing the officer’s compensation to shareholders, as is the case for smaller reporting companies). Also, once someone is considered to be a covered employee, he or she will remain a covered employee forever. TCJA further expanded the scope of Section 162(m) by amending the definition of “public corporation” to include many entities that would not generally be considered “publicly traded” under federal securities laws.

BDO Insights

Privately held companies that have a subsidiary that falls within the new definition of “publicly held corporation” might have compensation taken in to account that results in an allocation of the disallowed compensation deduction.

Partnership Loophole Closed

From 2006 to 2008, the IRS issued several private letter rulings concluding that the Section 162(m) $1 million deduction limit did not apply to amounts that public company executives received for services they provided to a partnership in which the company had an ownership interest. In 2010, the IRS recognized the potential for abuse and stopped issuing private letter rulings. The proposed rules clarify that such compensation is subject to the Section 162(m) limit effective December 20, 2019. But the IRS provided a transition rule for existing written agreements that are not materially modified after that date, since this issue had not been addressed in prior guidance, and taxpayers may have taken positions contrary to those set out in the proposed regulations.


Interim Guidance

On August 21, 2018, the IRS released Notice 2018-68, which provided preliminary, interim guidance on the TCJA changes and requested comments on many open issues. In light of those comments, the IRS has included numerous examples in the proposed regulations to illustrate how the new rules apply to specific situations. Importantly, for taxable years ending on or after December 20, 2019, taxpayers generally may no longer rely on the notice, but instead may rely on the proposed regulations for those taxable years (note that there are special applicability dates for certain changes outlined in the proposed regulations).


Grandfather Rule

The TCJA also provided limited transition relief for certain existing compensation arrangements. Specifically, the TCJA changes do not apply to compensation provided to a covered employee under a written binding contract (including a severance agreement) that was in effect on November 2, 2017, and was not modified on or after that date. The proposed regulations explain in detail how the “grandfather rule” works, including examples of when a contract will be considered materially modified so that it is no longer considered “grandfathered,” how earnings on grandfathered amounts are treated for Section 162(m) purposes, how accelerated payments and/or vesting are treated, and ordering rules that apply to payments that include both grandfathered and non-grandfathered amounts.


Proposed Regulations

The proposed regulations include guidance on the following:

  • What is a “publicly held corporation”? The new definition includes any entity that, as of the last day of its tax year, issues securities required to be registered under Section 12 of the Securities Exchange Act of 1934 (Exchange Act) or that is required to file reports under Section 15(d) of the Exchange Act - including subsidiaries that file reports under Section 15(d) of the Exchange Act, foreign private issuers, publicly traded partnerships, affiliated groups, disregarded entities, and “qualified subchapter S subsidiaries.” Under the proposed regulations, a publicly held corporation includes an affiliated group (under Internal Revenue Code Section 1504, without regard to Section 1504(b)) that includes one or more publicly held corporations. If an affiliated group includes two or more publicly held corporations, each publicly held member of the group would be separately subject to the proposed regulations, and the affiliated group as a whole would also be subject to the proposed regulations.
  • Who is a “covered employee”? The proposed rules address whom is an “executive officer,” confirm that individuals will remain covered employees after separation from service, and discuss how covered employee situations are handled when the individual performs (or performed) service with predecessor corporations, disregarded entities, and qualified subchapter S subsidiaries. The new rules also address how to handle taxable years not ending on same date as fiscal years. Generally, mergers or acquisitions involving a publicly held corporation will result in multiplication of covered employees if the remaining group contains a publicly held corporation. Prior status as a covered employee is also resurrected if a private company returns to publicly-held status within 36 months.

BDO Insights

After TCJA, it seemed logical to conclude that grandfathered nonqualified deferred compensation arrangements should be exempt from Section 162(m) if they provided for payment after separation from service (and otherwise satisfy the legally binding right requirements). While such amounts were not exempt as performance-based compensation, they nevertheless seemed to be outside of Section 162(m) because they were scheduled to be paid when the executive was no longer a covered employee. That conclusion was not explicitly clear in the Notice 2018-68, but it was logically consistent with other items in the notice. The proposed regulations confirm that this interpretation of the grandfathered arrangements is correct.

  • What is “applicable employee remuneration”? The new definition includes compensation paid by a partnership to a covered employee and compensation for services in a capacity other than an executive officer (such as director fees reported on Form 1099, not W-2) if paid to someone who is (or had been) covered by Section 162(m).
  • Are there still IPO transition rules? No. The proposed regulations eliminated the transition relief in existing Section 162(m) regulations for any corporation going public after December 20, 2019. The existing IPO transition relief was based on the pre-2017 exception for performance-based compensation under Section 162(m), so since that exception has been eliminated, the IRS said IPO transition rules are no longer necessary.
  • Is there Section 409A transition relief? Yes. The proposed regulations give employers until December 31, 2020, to remove provisions in their nonqualified deferred compensation arrangements that would have required delaying payments until the payment would be deductible under Section 162(m), without the change being treated as a material modification for purposes of the Section 162(m) grandfathering rule or as a Section 409A impermissible acceleration. Any payments that were previously suspended under the original plan provisions must be paid out by December 31, 2020.

Effective Date

The TCJA changes apply to tax years beginning after December 31, 2017, except to the extent the grandfather rule applies. The proposed regulations apply for taxable years ending on or after December 20, 2019, but under a transition rule, they will not apply to compensation paid pursuant to a written binding contract in effect on December 20, 2019, that is not materially modified after that date. Certain special deadlines may also apply to particular provisions (such as the Section 409A transition relief discussed above).

Taxpayers may rely on the proposed regulations for tax years before the regulations become final. The IRS is accepting comments on the proposed regulations through mid-February 2020 and plans to hold a public hearing on them on March 9, 2020.