Internal Revenue Code Section 162(m) generally limits the amount of compensation to certain individuals (Covered Individuals) that a publicly traded company may deduct as a business expense. The Tax Cuts and Jobs Act (TCJA) significantly modified the application of this limitation for taxable years beginning after December 31, 2017 for compensation arrangements entered into after November 2, 2017 (the Grandfathering Date). Proposed regulations (the Regulations) under the revised Code Section 162(m) were issued in December, 2019, and reflect the IRS’s position that the types of compensation now subject to the limitation will be interpreted broadly.
TCJA broadened the types of companies that would be considered “publicly traded,” and therefore subject to Code Section 162(m). Under the Regulations, a company will be considered publicly traded if it (i) offers any class of securities which must be registered under Section 12 of the S(m) (the 34 Act); or (ii) is required to file reports under section 15(d) of the 34 Act. The Regulations explicitly note that certain large private C or S corporations that issue (for example) publicly traded debt, but are not themselves publicly traded, will become subject to Code Section 162(m). In addition, certain subsidiary or parent organizations of publicly traded companies will themselves be subject to Code Section 162(m) even if they have no publicly traded securities. Finally, the Regulation appears to undo pre-TCJA sub-regulatory guidance which broadly exempted “foreign private issuers” from Code Section 162(m).
Prior to TCJA, Code Section 162(m) provided an “IPO Transition Period” which stayed the application of the deduction limitation to a company for the first year in which it was publicly traded. The Regulations eliminate this transition period. A privately held company will become immediately subject to Code Section 162(m)’s limitations upon an IPO, or the issuance of any security which meets the requirements in the preceding paragraph.
The Regulations also provide that Code Section 162(m) will apply to a privately held corporation that becomes a publicly held corporation beginning with compensation that is deductible for the taxable year ending on or after the date the corporation becomes a publicly held corporation.
In order to be considered grandfathered, a compensation arrangement must be a legally enforceable right (i.e., a binding contract between the employer and employee) which (i) is not subject to employer discretion as to its payment (termed “negative discretion”) and (ii) is entered into before the Grandfathering Date. For purposes of applying the grandfathering rule, separate pieces of compensation may be reviewed independently, even if they are described in the same agreement. Substantial modifications to otherwise grandfathered arrangements (other than certain specified changes required by Code Section 162(m) or Code Section 409A), may cause the arrangement to become immediately subject to the Regulations.
The Regulations contain a number of other changes, consistent with TCJA, which generally result in Code Section 162(m) applying to a broader swath of companies, Covered Individuals, and compensation arrangements than under previous guidance.
The full article in its original form can be found here.
John Eagan (LAW ’79) is the Managing Partner of the New York office of White and Williams, LLP. He focuses his practice on taxation matters, with particular emphasis on planning for US and international business clients. Mr. Eagan provides business tax counseling and planning on a variety of issues, including business entity transactional work (mergers, acquisitions, structures and reorganizations), business and tax structures for foreign investment in the US (business formation and investment structures, FIRPTA, transfer pricing, branch profits, repatriation and treaty issues), outbound structuring (including controlled foreign corporation issues), and S corporation, partnership, and limited liability company taxation.
Stephen Bowers, works as Of Counsel out of the Philadelphia office of White and Williams, LLP. Mr. Bowers serves a broad array of corporate clients and has notable experience guiding employers of all types, including private companies, government entities, nonprofits, and educational institutions through industry-specific employee compensation and benefits rules. He advises employers on the design, operation, and regulation of executive compensation agreements and employee pension and healthcare plans.