August 22, 2018 / North America
On August 21, 2018, the IRS issued Notice 2018-68, which provides some much-anticipated guidance on the application of amendments to section 162(m) of the Internal Revenue Code (Section 162(m)). Section 162(m) provides that compensation exceeding $1 million paid to certain “covered employees” of a publicly held corporation is nondeductible by the corporation.
Under prior law, compensation that was “performance-based” was not subject to the $1 million limitation. Additionally, the definition of “covered employee” excluded a corporation’s Chief Financial Officer (CFO). Finally, covered employees were identified at the end of each calendar year—independently of prior calendar years.
The 2017 Tax Cuts and Jobs Act (TCJA) modified Section 162(m) in several significant respects. First, it expanded the definition of “publicly held corporation” to include entities that would not have previously been subject to Section 162(m). Second, it expanded the definition of “covered employee” to include a corporation’s CFO. Additionally, covered employees now include any individual who would be a covered employee at any time during the current year, as well as anyone who was a covered employee in any prior year. Finally, the TCJA eliminated the “performance-based” compensation exception, so that the deduction limitation is now applied to all compensation exceeding $1 million, regardless of how it is classified.
The TCJA provided some transition relief for the amendments to Section 162(m). Generally, the amendments to Section 162(m) apply to taxable years beginning after December 31, 2017. However, the TCJA also provides that the amendments will not apply to compensation that is payable pursuant to a written binding contract in effect as of November 2, 2017, that is not materially modified after that date. The breadth and scope of this “grandfather rule” has been the subject of much debate. Notice 2018-68 answers many questions surrounding this grandfathering rule and brings some certainty to this area of the tax law. This article will address a few of these issues at length.