IRS provides initial guidance on new Sec. 162(m)

By Sally P. Schreiber, J.D.

In Notice 2018-68, the IRS issued guidance on Sec. 162(m), as amended by P.L. 115-97, the law known as the Tax Cuts and Jobs Act. As amended, Sec. 162(m) disallows a deduction by any publicly held corporation for employee remuneration paid to any covered employee to the extent that the employee’s remuneration for the tax year exceeds $1 million.

The amendments changed the definition of covered employees, broadened which publicly held corporations are subject to the law, and eliminated the exception from the $1 million limit for remuneration payable on a commission basis and qualified performance-based compensation. They also contain a grandfather rule allowing employment contracts to be governed by the old version of Sec. 162(m). Thus, the new rules apply after Dec. 31, 2017, except to a written binding contract that was in effect on Nov. 2, 2017, and was not modified in any material respect on or after that date.

The notice provides guidance on the definition of a “covered employee” and the operation of the grandfather rule, including how to determine whether a contract is a written binding contract and whether a contract has been materially modified. Both are illustrated with a number of examples. The IRS says it plans to issue regulations interpreting Sec. 162(m) generally but issued this interim guidance at stakeholders’ request.

Covered employee

A covered employee is defined as including any employee who is the principal executive officer (PEO) or principal financial officer (PFO) of the publicly held corporation at any time during the tax year or was an individual acting in that capacity. It also includes any employee whose total compensation for the tax year is required to be reported to shareholders under the Securities Exchange Act of 1934 because that employee is among the three highest-compensated officers for the tax year (other than the PEO or PFO, or an individual acting in that capacity). The IRS rejected suggestions that a covered employee must have been one as of the end of the tax year, providing instead that a covered employee is anyone who met that definition at any time during the year.

The rules also deemed employees to be covered employees if they were so in 2017 under the old version of Sec. 162(m). Thus, although the amended Sec. 162(m) applies beginning in 2018 generally, those employees who were covered employees under the old definition in 2017 remain covered employees under the new rules.

Written binding contract

Remuneration is payable under a written binding contract that was in effect on Nov. 2, 2017, only to the extent that the corporation is obligated under applicable law (e.g., state contract law) to pay the remuneration under the contract if the employee performs services or satisfies the required vesting conditions. Therefore, the amendments apply to any amount of remuneration that exceeds the amount of remuneration that the applicable law obligates a corporation to pay under such a contract.

The amendments also apply to a contract that is renewed after Nov. 2, 2017. If the corporation may cancel or terminate the contract without the employee’s consent, that contract is treated as renewed as of the date that any such termination or cancellation, if made, would be effective. There are also rules for contracts that may be canceled or terminated by both parties.

Material modification

A material modification occurs if a contract is amended to increase the amount of compensation paid to the employee; modified to accelerate the payment of compensation, unless the accelerated payment is discounted to reasonably reflect the time value of money; or modified to defer compensation in certain circumstances. The adoption of a supplemental contract or agreement that provides increased compensation or the payment of additional compensation under certain facts and circumstances will also be a material modification.

The IRS asked that written comments on the notice be sent by Nov. 9, 2018.

Sally P. Schreiber, J.D., ( is a JofA senior editor.

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