Tax Reform

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

J.D. Ivy, Managing Director

jivy@alvarezandmarsal.com

Brian Cumberland, Managing Director

bcumberland@alvarezandmarsal.com

James Deets, Senior Director

jdeets@alvarezandmarsal.com

John Schultz, Managing Director

jschultz@alvarezandmarsal.com

Brennan Rittenhouse, Managing Director

brittenhouse@alvarezandmarsal.com

Kim Schultz, Managing Director

kimschultz@alvarezandmarsal.com

September 21, 2018 / North America

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 TAXAND 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


North America