IRS issues proposed regulations on TCJA changes to Section 162(m) $1M compensation deduction limit

Since 1993, Internal Revenue Code Section 162(m) has imposed a $1 million deduction limitation on compensation paid to certain “covered employees” of publicly held corporations. The Tax Cuts and Jobs Act of 2017 (TCJA) significantly altered these rules by:

- Eliminating the prior-law exceptions for commissions and for “qualified performance-based compensation.” 

- Treating the principal financial officer as a “covered employee.”

- Eliminating the “employment on the last day of the corporation’s tax year” requirement for “covered employee” status.

- Establishing that once an individual is a “covered employee,” he or she remains subject to the $1 million deduction limitation indefinitely.

- Expanding the “publicly held corporation” standard to include companies required to report under Section 15(d) of the Securities Exchange Act of 1934 (the Exchange Act), foreign private issuers, or private companies with registered debt offerings.

- Providing certain limited grandfathering relief for arrangements in place under a written binding contract as of Nov. 2, 2017.

In 2018, the IRS issued Notice 2018-68, which provided interim guidance on the TCJA changes until proposed regulations were issued. Those proposed regulations have now been issued, some of which mirror the guidance provided in the Notice. (Per the IRS, now that proposed regulations have been issued, the Notice may no longer be relied upon.) Except as otherwise noted below, the proposed regulations are to become effective on the date on which final regulations are issued. 

Proposed regulations

“Publicly held corporation”

- Any corporation (including an S corporation) that as of the last day of its tax year is required to 1) register its securities under Section 12 of the Exchange Act (i.e., list securities for trading on a national exchange, or, where assets exceed $10 million, register securities held by 2,000 or more persons or 500 or more non-accredited investors), or 2) file reports under Section 15(d) of the Exchange Act (i.e., private foreign issuers of ADRs traded in the U.S. or certain issuers of public debt). 

- These determinations are to be made as of the last day of the corporation’s tax year. (If registration or the filing requirement is suspended as of the last day of such year, Section 162(m) is not applicable.) 

- Applies to publicly traded partnerships that are treated as corporations for federal tax purposes (e.g., under Section 7704).

- Applies to “foreign private issuers” subject to Section 15(d), even if the reports are not required to provide a summary compensation table; however, the IRS has requested comments as to a possible safe harbor for foreign private issuers that are not required to disclose the compensation of their officers.

- The requirements apply separately to a subsidiary (and its covered employees) of a publicly held corporation that is itself a publicly held corporation.

- A corporation that owns a disregarded entity is treated as the issuer of any securities issued by the disregard.

“Covered employees” 

- Anyone who was principal executive officer or principal financial officer at any time during the corporation’s tax year.  

- Determined on the basis of the SEC disclosure rules, the three highest-paid executive officers for the corporation’s tax year (regardless of whether the officer is employed on the last day of the corporation’s tax year)

-As the SEC disclosures are based on the corporation’s fiscal year, where a corporation’s fiscal and tax year differ, the determination of the three highest-paid executive officers is based upon the SEC rules, but using the tax year-end as the fiscal year-end for such purpose.

- Once a “covered employee,” the individual remains subject to the $1 million deduction limitation indefinitely. 

- Effective for tax years ending on or after Sept. 10, 2018.

- Predecessor corporations 

- “Covered employee” includes any employee who was a covered employee of a “predecessor corporation” for any preceding tax year beginning after Dec. 31, 2016. The following would be considered a “predecessor corporation”:

- A publicly held corporation that goes private and then again becomes public within 36 months of the due date of the last income tax return filed for when it was publicly held.

- A publicly held corporation acquired via a stock sale or an 80% or greater assets sale.

- A publicly held corporation that is acquired or is the transferor in a Section 368(a)(1) reorganization.

- A subsidiary spun off to its shareholders by a publicly held corporation.

- Effective for transactions that occur on or after the date on which final regulations are issued.

Partnership level compensation

- Compensation now includes payments to a covered employee by an operating partnership to the extent that the publicly held corporation is allocated a distributive share of the partnership’s compensation deduction.

- Effective for tax years ending on or after Dec. 20, 2019.

Elimination of IPO transition rule

- The prior-law transition rule that deferred the applicability of Section 162(m) to corporations undergoing an IPO is no longer available.

- Effective for IPOs occurring after Dec. 20, 2019.

Modification of grandfather rule

- Accelerated vesting will not be treated as a material modification that would otherwise preclude grandfathering of an arrangement under a written binding contract in place as of Nov. 2, 2017.

What does CohnReznick think?

In lieu of amending the existing 1995 treasury regulations under Section 162(m), the 2019 proposed regulations are a full re-write under the TCJA rules. Perhaps the most significant aspect is the applicability of Section 162(m) not only to public corporations, but also to certain publicly traded partnerships, foreign filers, and companies with public debt. The elimination of the IPO transition rule is also significant. Finally, the permissibility of accelerated vesting without the disruption of the effectiveness of grandfathering is very welcome. The IRS has indicated its intention to finalize these regulations during 2020.


Dana Fried, Managing Director, National Tax Services


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    Dana Fried

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