162 m limitation and stock options

The $1 million deduction limit under Section 162(m) applies to employees stock grant is based on stock price and continued employment). guidance from the IRS on the $1 million deduction limit under Code Section 162(m). When the Tax Cuts and Jobs Act of 2017 (TCJA) was enacted. The New York Stock Exchange and NASDAQ instituted new corporate Code Section 162(m) generally limits to $1,000,000 the tax deduction for annual. 162 m limitation and stock options

162 m limitation and stock options -

New 162(m) Guidance: IRS Notice 2018-68 Clarifies Scope of Tax Reform and Transition Rules


Section 162(m) of the Internal Revenue Code denies a tax deduction to a public company for compensation paid to certain individuals—called “covered employees ”—to the extent that the compensation paid to such individual exceeds $1,000,000 for the taxable year.

In 2017, Section 162(m) was amended to, among other things:

  • Expand the definition of a “covered employee”,
  • Expand the definition of a “public company” subject to Section 162(m), and
  • Apply the 162(m) deduction limitation to commission pay and performance-based compensation, which had been previously exempted from the 162(m) deduction limitation.

These 2017 amendments apply to all taxable years beginning on or after January 1, 2018. However, an exception to this rule provides that compensation payable pursuant to written binding contracts in force as of November 2, 2017, will remain subject to the 162(m)deduction limitations that were in effect prior to the 2017 amendments, until such contracts are materially modified (referred to in this client alert as the “grandfathering rule ” and “grandfathered compensation ”). Please see our prior client alert for additional details, “Congress Approves Tax Reform Bill Impacting Equity Compensation.”

On August 21, 2018, the IRS issued Notice 2018-68 which clarified the scope of the 2017 amendments. These clarifications are effective for taxable years ending on or after September 10, 2018. A summary of key points follows:

  • Covered Employees Interpreted Broadly. The 2017 amendments expanded the definition of a “covered employee” to include an employee of a public company who:
    1. Served as the principal executive officer or the principal financial officer of the company (or acted in such capacity) at any time during the taxable year,
    2. Is the among the three highest compensated executive officers for the taxable year (other than an individual described in (1)), or
    3. Was a covered employee of the company or a predecessor at any time after December 31, 2016 (this includes an individual who was a covered employee for 2017 as determined under the pre-amended rules).
    An individual is a covered employee regardless of whether the individual is employed at the end of the taxable year, and regardless of whether disclosure of his or her compensation is required under SEC rules.
  • Grandfathering Rule Interpreted Narrowly. The relief provided by the grandfathering rule is narrow. Specifically, compensation will not be treated as payable pursuant to a “written binding contract,” and as such will not be grandfathered, to the extent that the amount of the compensation can be decreased in the company’s discretion after November 2, 2017. Compensation will also not be grandfathered if the grant of the compensation remained subject to a condition as of November 2, 2017, such as a grant that is subject to board approval. Examples of the narrow relief are provided below.

    As described above, the 2017 amendments provided that compensation payable pursuant to a grandfathered contract becomes subject to the new Section 162(m)deduction limitation rules once the contract is “materially modified.” The new IRS guidance defines a “material modification” to mean an amendment to increase the compensation payable to the employee under the contract. However, the new IRS guidance provides limited exceptions to this rule for reasonable cost of living increases and additional compensation paid on the basis of elements or conditions that are not substantially the same as the elements or conditions that are the basis for grandfathered compensation.

Practical Tips

  • Grandfathering. When applying the grandfathering rule, the first consideration should be whether the covered employee would have been a covered employee for the taxable year if the pre-amended rules had continued to apply.

    We expect the grandfathering rule to have the greatest impact when the covered employee wouldnot have been a covered employee for the taxable year under the pre-amended rules.1 In this case, all compensation under a grandfathered contract (even non-performance based) will remain deductible until the contract is materially modified.

    The grandfathering rule will also apply in the case of a covered employee who would have been a covered employee for the taxable year under the pre-amended rules. However, in this case, grandfathered compensation will remain deductible onlyif such compensation would have qualified as deductible performance-based compensation under the pre-amended rules, and only until the grandfathered contract is materially modified.
  • Negative Discretion. Under the pre-amended rules, many performance-based arrangements provided for shareholder approval of a reach target and allowed the compensation committee to use negative discretion to arrive at a lower actual payout. As described above, Notice 2018-68 provides that performance-based compensation under this type of plan will be grandfathered only to the extent that the compensation was not subject to the company’s negative discretion as of November 2, 2017. For example, if a plan established in early 2017 allowed the company’s compensation committee to apply negative discretion to reduce a payout to a covered employee to $0, then none of the compensation payable pursuant to this plan will be grandfathered.
  • Recordkeeping. Public companies will now need to implement robust compensation recordkeeping protocols for a greater number of employees. This is because public companies will be required to identify their three highest compensated executive officers (other than their principal executive officer and principal financial officer) in accordance with the SEC’s compensation disclosure framework, even if those persons are not subject to SEC disclosure rules. This includes smaller reporting companies and emerging growth companies, despite the scaled-down SEC compensation disclosure requirements that apply to these companies.
  • Incentive Stock Options. When an employee exercises an incentive stock option, he or she has no ordinary taxable income upon exercise, and if the shares are held for requisite holding periods, the sale proceeds are capital gains. As a result of the 2017 amendments, many public companies may no longer receive a deduction when their executive officers exercise their stock options. Since the company would stand to lose the deduction under Section 162(m) anyway, this may make incentive stock options more attractive.
  • Alternative Forms of Compensation. A grandfathered contract will be considered “materially modified” if it is amended in order to increase the compensation payable under it. However, it is not a material modification to provide a covered employee with additional compensation in another form—even if that new compensation is subject to the 162(m) deduction limitation under the new rules—so long as the new compensation is paid on the basis of elements or conditions that are not substantially the same as the elements or conditions for grandfathered compensation.2
  • More to Come Regarding IPO and M&A Considerations. The recent IRS guidance does not address the application of Section 162(m) to corporations immediately after they become public through an initial public offering or a similar business transaction, or to an employee who was a covered employee of a predecessor of the public company.

Fenwick & West will continue to closely monitor any developments and encourages clients to reach out with questions.


1 For instance, a principal financial officer will qualify as a covered employee for all taxable years beginning after January 1, 2018, but generally was excluded from the 162(m)deduction limitation rules in prior tax years. However, we note that in a Chief Counsel Advice (CCA) legal memorandum issued on August 24, 2015, the IRS concluded that a principal financial officer of a smaller reporting company can be a covered employee for a taxable year if he or she is one of the two highest compensated executive officers of the company. The CCA left open the question of whether the same analysis would apply in the case of a principal financial officer of an emerging growth company.

2 For example, assume that an employee who is not a covered employee receives a written binding commitment on August 1, 2017 to receive $500,000 on June 1, 2018. On January 1, 2018, the employee becomes a “covered employee” due to the tax reform. If the company increases the total payout to $800,000, the entire amount will be subject to the 162(m) deduction limitation. However, if the payment remains $500,000, but the company grants new awards of restricted stock worth $300,000, only the new stock awards will be subject to the 162(m) deduction limitation, and the payout under the original contract will remain grandfathered.

Источник: https://www.fenwick.com/insights/publications/new-162m-guidance-irs-notice-2018-68-clarifies-scope-of-tax-reform-and-transition-rules

We are pleased to share the following insights from Attorney Michael S. Melbinger, first published January 7, 2020 on the EXECUTIVE COMPENSATION BLOG.

Fair Treatment for CFOs under the New 162(m) Proposed Regulations

Last month year, I blogged on the new Proposed Regulations issued by IRS and the Treasury Department on the changes to Code Section 162(m) made by the Tax Cuts and Jobs Act of 2017 (TCJA). This is a major development for executive compensation professionals, but I stopped blogging when we went into the Holiday Season (and I began to receive a 50% out-of-office bounce-back rate). But the party is over and I will continue by focusing on one aspect of the proposed regs at a time. Today’s topic is the exemption of a certain amount paid to the CFO under the transition/grandfathering rules of Section 162(m), as embellished by the proposed regs. Under the proposed regulations (and in our experience), CFOs are the most likely class of current executives to enjoy grandfathering protection for amounts paid pursuant to a written binding contract in effect on November 2, 2017.

Readers will recall that amounts paid pursuant to a written binding contract in effect on November 2, 2017, may be exempt from the $1 million deductibility limit of 162(m) under certain conditions. For example, certain incentive awards made before November 2, 2017, which satisfied the performance-based compensation requirements of pre-TCJA provision of 162(m) (e.g., stock options and performance shares) could be entitled to grandfathering status and be exempt from the deductibility limit when paid or exercise in subsequent years.

The grandfathering rules for CFOs are even more favorable. Prior to November 2, 2017, a company’s CFO was not a “covered person” under 162(m) and, therefore not subject to the $1 million deductibility limit. Thus, compensation paid or accrued to the CFO pursuant to a grandfathered employment agreement could be exempt, even if the amounts are not performance-based. The proposed regs. provide the following example, which I have edited for brevity:

On October 2, 2017, Corporation executed a 3-year employment agreement with its CFO for an annual salary of $2,000,000 beginning on January 1, 2018. The agreement provides for automatic extensions after the 3-year term for additional 1-year periods, unless the Corporation exercises its option to terminate the agreement within 30 days before the end of the 3-year term or, thereafter, within 30 days before each anniversary date. Termination of the employment agreement does not require the termination of the CFO’s employment with Corporation. Under applicable law, the agreement for annual salary constitutes a written binding contract in effect on November 2, 2017, to pay $2,000,000 of annual salary to the CFO for three years through December 31, 2020. Because the October 2, 2017, employment agreement:

  1. is a written binding contract to pay the CFO an annual salary of $2,000,000, and
  2. the CFO is not a covered employee for the Corporation’s 2018 through 2020 taxable years,

The deduction for the CFO’s annual salary for the 2018 through 2020 taxable years is not subject to section 162(m). However, the employment agreement is treated as renewed on January 1, 2021, unless it is previously terminated, and the $1 million limit will apply to the deduction for any payments made under the employment agreement on or after that date (not grandfathered).

The foregoing example also illustrates the complicated contract renewal and termination issues that apply to agreements that otherwise would be grandfather, but we will save those issues for another day.

Related content:

#executivecomp #executivecompensation #162m #taxcode #TCJA

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Any tax advice contained herein is of a general nature. You should seek specific advice from your tax professional before pursuing any idea contemplated herein.

Securities offered through Lion Street Financial, LLC (LSF) and Valmark Securities, Inc. (VSI), each a member of FINRA and SIPC. Investment advisory services offered through CapAcuity, LLC; Lion Street Advisors, LLC (LSF) and Valmark Advisers, Inc. (VAI), each an SEC registered investment advisor. Please refer to your investment advisory agreement and the Form ADV disclosures provided to you for more information. VAI/VSI, LSF and CapAcuity, LLC. are non-affiliated entities and separate entities from OneDigital and Fulcrum Partners.

Unless otherwise noted, VAI/VSI, LSF are not affiliated, associated, authorized, endorsed by, or in any way officially connected with any other company, agency or government agency identified or referenced in this document.

No items found

Related Deferred Compensation and Executive Benefit Topics

Источник: https://www.fulcrumpartnersllc.com/2020/01/13/major-development-for-executive-compensation-professionals/

26 CFR § 1.162-27 - Certain employee remuneration in excess of $1,000,000 not deductible for taxable years beginning on or after January 1, 1994, and for taxable years beginning prior to January 1, 2018.

§ 1.162-27 Certain employee remuneration in excess of $1,000,000 not deductible for taxable years beginning on or after January 1, 1994, and for taxable years beginning prior to January 1, 2018.

(a)Scope. This section provides rules for the application of the $1 million deduction limitation under section 162(m)(1) for taxable years beginning on or after January 1, 1994, and beginning prior to January 1, 2018, and, as provided in paragraph (j) of this section, for taxable years beginning after December 31, 2017. For rules concerning the applicability of section 162(m)(1) to taxable years beginning after December 31, 2017, see § 1.162-33. Paragraph (b) of this section provides the general rule limiting deductions under section 162(m)(1). Paragraph (c) of this section provides definitions of generally applicable terms. Paragraph (d) of this section provides an exception from the deduction limitation for compensation payable on a commission basis. Paragraph (e) of this section provides an exception for qualified performance-based compensation. Paragraphs (f) and (g) of this section provide special rules for corporations that become publicly held corporations and payments that are subject to section 280G, respectively. Paragraph (h) of this section provides transition rules, including the rules for contracts that are grandfathered and not subject to section 162(m)(1). Paragraph (j) of this section contains the effective date provisions, which also specify when these rules apply to the deduction for compensation otherwise deductible in a taxable year beginning after December 31, 2017. For rules concerning the deductibility of compensation for services that are not covered by section 162(m)(1) and this section, see section 162(a)(1) and § 1.162-7. This section is not determinative as to whether compensation meets the requirements of section 162(a)(1). For rules concerning the deduction limitation under section 162(m)(6) applicable to certain health insurance providers, see § 1.162-31.

(b)Limitation on deduction. Section 162(m) precludes a deduction under chapter 1 of the Internal Revenue Code by any publicly held corporation for compensation paid to any covered employee to the extent that the compensation for the taxable year exceeds $1,000,000.

(c)Definitions -

(1)Publicly held corporation -

(i)General rule. A publicly held corporation means any corporation issuing any class of common equity securities required to be registered under section 12 of the Exchange Act. A corporation is not considered publicly held if the registration of its equity securities is voluntary. For purposes of this section, whether a corporation is publicly held is determined based solely on whether, as of the last day of its taxable year, the corporation is subject to the reporting obligations of section 12 of the Exchange Act.

(ii)Affiliated groups. A publicly held corporation includes an affiliated group of corporations, as defined in section 1504 (determined without regard to section 1504(b)). For purposes of this section, however, an affiliated group of corporations does not include any subsidiary that is itself a publicly held corporation. Such a publicly held subsidiary, and its subsidiaries (if any), are separately subject to this section. If a covered employee is paid compensation in a taxable year by more than one member of an affiliated group, compensation paid by each member of the affiliated group is aggregated with compensation paid to the covered employee by all other members of the group. Any amount disallowed as a deduction by this section must be prorated among the payorcorporations in proportion to the amount of compensation paid to the covered employee by each such corporation in the taxable year.

(2)Covered employee -

(i)General rule. A covered employee means any individual who, on the last day of the taxable year, is -

(A) The chief executive officer of the corporation or is acting in such capacity; or

(B) Among the four highest compensated officers (other than the chief executive officer).

(ii)Application of rules of the Securities and Exchange Commission. Whether an individual is the chief executive officer described in paragraph (c)(2)(i)(A) of this section or an officer described in paragraph (c)(2)(i)(B) of this section is determined pursuant to the executive compensation disclosure rules under the Exchange Act.

(3)Compensation -

(i)In general. For purposes of the deduction limitation described in paragraph (b) of this section, compensation means the aggregate amount allowable as a deduction under chapter 1 of the Internal Revenue Code for the taxable year (determined without regard to section 162(m)) for remuneration for services performed by a covered employee, whether or not the services were performed during the taxable year.

(ii)Exceptions. Compensation does not include -

(A) Remuneration covered in section 3121(a)(5)(A) through section 3121(a)(5)(D) (concerning remuneration that is not treated as wages for purposes of the Federal Insurance Contributions Act); and

(B) Remuneration consisting of any benefit provided to or on behalf of an employee if, at the time the benefit is provided, it is reasonable to believe that the employee will be able to exclude it from gross income. In addition, compensation does not include salary reduction contributions described in section 3121(v)(1).

(4)Compensation Committee. The compensation committee means the committee of directors (including any subcommittee of directors) of the publicly held corporation that has the authority to establish and administer performance goals described in paragraph (e)(2) of this section, and to certify that performance goals are attained, as described in paragraph (e)(5) of this section. A committee of directors is not treated as failing to have the authority to establish performance goals merely because the goals are ratified by the board of directors of the publicly held corporation or, if applicable, any other committee of the board of directors. See paragraph (e)(3) of this section for rules concerning the composition of the compensation committee.

(5)Exchange Act. The Exchange Act means the Securities Exchange Act of 1934.

(6)Examples. This paragraph (c) may be illustrated by the following examples:

Example 1.

Corporation X is a publicly held corporation with a July 1 to June 30 fiscal year. For Corporation X's taxable year ending on June 30, 1995, Corporation X pays compensation of $2,000,000 to A, an employee. However, A's compensation is not required to be reported to shareholders under the executive compensation disclosure rules of the Exchange Act because A is neither the chief executive officer nor one of the four highest compensated officers employed on the last day of the taxable year. A's compensation is not subject to the deduction limitation of paragraph (b) of this section.

Example 2.

C, a covered employee, performs services and receives compensation from Corporations X, Y, and Z, members of an affiliated group of corporations. Corporation X, the parent corporation, is a publicly held corporation. The total compensation paid to C from all affiliated group members is $3,000,000 for the taxable year, of which Corporation X pays $1,500,000; Corporation Y pays $900,000; and Corporation Z pays $600,000. Because the compensation paid by all affiliated group members is aggregated for purposes of section 162(m), $2,000,000 of the aggregate compensation paid is nondeductible. Corporations X, Y, and Z each are treated as paying a ratable portion of the nondeductible compensation. Thus, two thirds of each corporation's payment will be nondeductible. Corporation X has a nondeductible compensation expense of $1,000,000 ($1,500,000 × $2,000,000/$3,000,000). Corporation Y has a nondeductible compensation expense of $600,000 ($900,000 × $2,000,000/$3,000,000). Corporation Z has a nondeductible compensation expense of $400,000 ($600,000 × $2,000,000/$3,000,000).

Example 3.

Corporation W, a calendar year taxpayer, has total assets equal to or exceeding $5 million and a class of equity security held of record by 500 or more persons on December 31, 1994. However, under the Exchange Act, Corporation W is not required to file a registration statement with respect to that security until April 30, 1995. Thus, Corporation W is not a publicly held corporation on December 31, 1994, but is a publicly held corporation on December 31, 1995.

Example 4.

The facts are the same as in Example 3, except that on December 15, 1996, Corporation W files with the Securities and Exchange Commission to disclose that Corporation W is no longer required to be registered under section 12 of the Exchange Act and to terminate its registration of securities under that provision. Because Corporation W is no longer subject to Exchange Act reporting obligations as of December 31, 1996, Corporation W is not a publicly held corporation for taxable year 1996, even though the registration of Corporation W's securities does not terminate until 90 days after Corporation W files with the Securities and Exchange Commission.

(d)Exception for compensation paid on a commission basis. The deduction limit in paragraph (b) of this section shall not apply to any compensation paid on a commission basis. For this purpose, compensation is paid on a commission basis if the facts and circumstances show that it is paid solely on account of income generated directly by the individual performance of the individual to whom the compensation is paid. Compensation does not fail to be attributable directly to the individual merely because supportservices, such as secretarial or research services, are utilized in generating the income. However, if compensation is paid on account of broader performance standards, such as income produced by a business unit of the corporation, the compensation does not qualify for the exception provided under this paragraph (d).

(e)Exception for qualified performance-based compensation -

(1)In general. The deduction limit in paragraph (b) of this section does not apply to qualified performance-based compensation. Qualified performance-based compensation is compensation that meets all of the requirements of paragraphs (e)(2) through (e)(5) of this section.

(2)Performance goal requirement -

(i)Preestablished goal. Qualified performance-based compensation must be paid solely on account of the attainment of one or more preestablished, objective performance goals. A performance goal is considered preestablished if it is established in writing by the compensation committee not later than 90 days after the commencement of the period of service to which the performance goal relates, provided that the outcome is substantially uncertain at the time the compensation committee actually establishes the goal. However, in no event will a performance goal be considered to be preestablished if it is established after 25 percent of the period of service (as scheduled in good faith at the time the goal is established) has elapsed. A performance goal is objective if a third party having knowledge of the relevant facts could determine whether the goal is met. Performance goals can be based on one or more business criteria that apply to the individual, a business unit, or the corporation as a whole. Such business criteria could include, for example, stock price, market share, sales, earnings per share, return on equity, or costs. A performance goal need not, however, be based upon an increase or positive result under a business criterion and could include, for example, maintaining the status quo or limiting economic losses (measured, in each case, by reference to a specific business criterion). A performance goal does not include the mere continued employment of the covered employee. Thus, a vesting provision based solely on continued employment would not constitute a performance goal. See paragraph (e)(2)(vi) of this section for rules on compensation that is based on an increase in the price of stock.

(ii)Objective compensation formula. A preestablished performance goal must state, in terms of an objective formula or standard, the method for computing the amount of compensation payable to the employee if the goal is attained. A formula or standard is objective if a third party having knowledge of the relevant performance results could calculate the amount to be paid to the employee. In addition, a formula or standard must specify the individual employees or class of employees to which it applies.

(iii)Discretion.

(A) The terms of an objective formula or standard must preclude discretion to increase the amount of compensation payable that would otherwise be due upon attainment of the goal. A performance goal is not discretionary for purposes of this paragraph (e)(2)(iii) merely because the compensation committee reduces or eliminates the compensation or other economic benefit that was due upon attainment of the goal. However, the exercise of negative discretion with respect to one employee is not permitted to result in an increase in the amount payable to another employee. Thus, for example, in the case of a bonus pool, if the amount payable to each employee is stated in terms of a percentage of the pool, the sum of these individual percentages of the pool is not permitted to exceed 100 percent. If the terms of an objective formula or standard fail to preclude discretion to increase the amount of compensation merely because the amount of compensation to be paid upon attainment of the performance goal is based, in whole or in part, on a percentage of salary or base pay and the dollar amount of the salary or base pay is not fixed at the time the performance goal is established, then the objective formula or standard will not be considered discretionary for purposes of this paragraph (e)(2)(iii) if the maximum dollar amount to be paid is fixed at that time.

(B) If compensation is payable upon or after the attainment of a performance goal, and a change is made to accelerate the payment of compensation to an earlier date after the attainment of the goal, the change will be treated as an increase in the amount of compensation, unless the amount of compensation paid is discounted to reasonably reflect the time value of money. If compensation is payable upon or after the attainment of a performance goal, and a change is made to defer the payment of compensation to a later date, any amount paid in excess of the amount that was originally owed to the employee will not be treated as an increase in the amount of compensation if the additional amount is based either on a reasonable rate of interest or on one or more predetermined actual investments (whether or not assets associated with the amount originally owed are actually invested therein) such that the amount payable by the employer at the later date will be based on the actual rate of return of a specific investment (including any decrease as well as any increase in the value of an investment). If compensation is payable in the form of property, a change in the timing of the transfer of that property after the attainment of the goal will not be treated as an increase in the amount of compensation for purposes of this paragraph (e)(2)(iii). Thus, for example, if the terms of a stock grant provide for stock to be transferred after the attainment of a performance goal and the transfer of the stock also is subject to a vesting schedule, a change in the vesting schedule that either accelerates or defers the transfer of stock will not be treated as an increase in the amount of compensation payable under the performance goal.

(C)Compensation attributable to a stockoption, stock appreciation right, or other stock-based compensation does not fail to satisfy the requirements of this paragraph (e)(2) to the extent that a change in the grant or award is made to reflect a change in corporate capitalization, such as a stock split or dividend, or a corporate transaction, such as any merger of a corporation into another corporation, any consolidation of two or more corporations into another corporation, any separation of a corporation (including a spinoff or other distribution of stock or property by a corporation), any reorganization of a corporation (whether or not such reorganization comes within the definition of such term in section 368), or any partial or complete liquidation by a corporation.

(iv)Grant-by-grant determination. The determination of whether compensation satisfies the requirements of this paragraph (e)(2) generally shall be made on a grant-by-grant basis. Thus, for example, whether compensation attributable to a stockoption grant satisfies the requirements of this paragraph (e)(2) generally is determined on the basis of the particular grant made and without regard to the terms of any other option grant, or other grant of compensation, to the same or another employee. As a further example, except as provided in paragraph (e)(2)(vi), whether a grant of restricted stock or other stock-based compensation satisfies the requirements of this paragraph (e)(2) is determined without regard to whether dividends, dividend equivalents, or other similar distributions with respect to stock, on such stock-based compensation are payable prior to the attainment of the performance goal. Dividends, dividend equivalents, or other similar distributions with respect to stock that are treated as separate grants under this paragraph (e)(2)(iv) are not performance-based compensation unless they separately satisfy the requirements of this paragraph (e)(2).

(v)Compensation contingent upon attainment of performance goal.Compensation does not satisfy the requirements of this paragraph (e)(2) if the facts and circumstances indicate that the employee would receive all or part of the compensation regardless of whether the performance goal is attained. Thus, if the payment of compensation under a grant or award is only nominally or partially contingent on attaining a performance goal, none of the compensation payable under the grant or award will be considered performance-based. For example, if an employee is entitled to a bonus under either of two arrangements, where payment under a nonperformance-based arrangement is contingent upon the failure to attain the performance goals under an otherwise performance-based arrangement, then neither arrangement provides for compensation that satisfies the requirements of this paragraph (e)(2). Compensation does not fail to be qualified performance-based compensation merely because the planallows the compensation to be payable upon death, disability, or change of ownership or control, although compensation actually paid on account of those events prior to the attainment of the performance goal would not satisfy the requirements of this paragraph (e)(2). As an exception to the general rule set forth in the first sentence of paragraph (e)(2)(iv) of this section, the facts-and-circumstances determination referred to in the first sentence of this paragraph (e)(2)(v) is made taking into account all plans, arrangements, and agreements that provide for compensation to the employee.

(vi)Application of requirements to stock options and stock appreciation rights -

(A)In general.Compensation attributable to a stockoption or a stock appreciation right is deemed to satisfy the requirements of this paragraph (e)(2) if the grant or award is made by the compensation committee; the plan under which the option or right is granted states the maximum number of shares with respect to which options or rights may be granted during a specified period to any individual employee; and, under the terms of the option or right, the amount of compensation the employee may receive is based solely on an increase in the value of the stock after the date of the grant or award. A plan may satisfy the requirement to provide a maximum number of shares with respect to which stock options and stock appreciation rights may be granted to any individual employee during a specified period if the plan specifies an aggregate maximum number of shares with respect to which stock options, stock appreciation rights, restricted stock, restricted stock units and other equity-based awards that may be granted to any individual employee during a specified period under a plan approved by shareholders in accordance with § 1.162-27(e)(4). If the amount of compensation the employee may receive under the grant or award is not based solely on an increase in the value of the stock after the date of grant or award (for example, in the case of restricted stock, or an option that is granted with an exercise price that is less than the fair market value of the stock as of the date of grant), none of the compensation attributable to the grant or award is qualified performance-based compensation under this paragraph (e)(2)(vi)(A). Whether a stockoption grant is based solely on an increase in the value of the stock after the date of grant is determined without regard to any dividend equivalent that may be payable, provided that payment of the dividend equivalent is not made contingent on the exercise of the option. The rule that the compensation attributable to a stockoption or stock appreciation right must be based solely on an increase in the value of the stock after the date of grant or award does not apply if the grant or award is made on account of, or if the vesting or exercisability of the grant or award is contingent on, the attainment of a performance goal that satisfies the requirements of this paragraph (e)(2).

(B)Cancellation and repricing.Compensation attributable to a stockoption or stock appreciation right does not satisfy the requirements of this paragraph (e)(2) to the extent that the number of options granted exceeds the maximum number of shares for which options may be granted to the employee as specified in the plan. If an option is canceled, the canceled option continues to be counted against the maximum number of shares for which options may be granted to the employee under the plan. If, after grant, the exercise price of an option is reduced, the transaction is treated as a cancellation of the option and a grant of a new option. In such case, both the option that is deemed to be canceled and the option that is deemed to be granted reduce the maximum number of shares for which options may be granted to the employee under the plan. This paragraph (e)(2)(vi)(B) also applies in the case of a stock appreciation right where, after the award is made, the base amount on which stock appreciation is calculated is reduced to reflect a reduction in the fair market value of stock.

(vii)Examples. This paragraph (e)(2) may be illustrated by the following examples:

Example 1.

No later than 90 days after the start of a fiscal year, but while the outcome is substantially uncertain, Corporation S establishes a bonus plan under which A, the chief executive officer, will receive a cash bonus of $500,000, if year-end corporate sales are increased by at least 5 percent. The compensation committee retains the right, if the performance goal is met, to reduce the bonus payment to A if, in its judgment, other subjective factors warrant a reduction. The bonus will meet the requirements of this paragraph (e)(2).

Example 2.

The facts are the same as in Example 1, except that the bonus is based on a percentage of Corporation S's total sales for the fiscal year. Because Corporation S is virtually certain to have some sales for the fiscal year, the outcome of the performance goal is not substantially uncertain, and therefore the bonus does not meet the requirements of this paragraph (e)(2).

Example 3.

The facts are the same as in Example 1, except that the bonus is based on a percentage of Corporation S's total profits for the fiscal year. Although some sales are virtually certain for virtually all public companies, it is substantially uncertain whether a company will have profits for a specified future period even if the company has a history of profitability. Therefore, the bonus will meet the requirements of this paragraph (e)(2).

Example 4.

B is the general counsel of Corporation R, which is engaged in patent litigation with Corporation S. Representatives of Corporation S have informally indicated to Corporation R a willingness to settle the litigation for $50,000,000. Subsequently, the compensation committee of Corporation R agrees to pay B a bonus if B obtains a formal settlement for at least $50,000,000. The bonus to B does not meet the requirement of this paragraph (e)(2) because the performance goal was not established at a time when the outcome was substantially uncertain.

Example 5.

Corporation S, a public utility, adopts a bonus plan for selected salaried employees that will pay a bonus at the end of a 3-year period of $750,000 each if, at the end of the 3 years, the price of S stock has increased by 10 percent. The plan also provides that the 10-percent goal will automatically adjust upward or downward by the percentage change in a published utilities index. Thus, for example, if the published utilities index shows a net increase of 5 percent over a 3-year period, then the salaried employees would receive a bonus only if Corporation S stock has increased by 15 percent. Conversely, if the published utilities index shows a net decrease of 5 percent over a 3-year period, then the salaried employees would receive a bonus if Corporation S stock has increased by 5 percent. Because these automatic adjustments in the performance goal are preestablished, the bonus meets the requirement of this paragraph (e)(2), notwithstanding the potential changes in the performance goal.

Example 6.

The facts are the same as in Example 5, except that the bonus plan provides that, at the end of the 3-year period, a bonus of $750,000 will be paid to each salaried employee if either the price of Corporation S stock has increased by 10 percent or the earnings per share on Corporation S stock have increased by 5 percent. If both the earnings-per-share goal and the stock-price goal are preestablished, the compensation committee's discretion to choose to pay a bonus under either of the two goals does not cause any bonus paid under the plan to fail to meet the requirement of this paragraph (e)(2) because each goal independently meets the requirements of this paragraph (e)(2). The choice to pay under either of the two goals is tantamount to the discretion to choose not to pay under one of the goals, as provided in paragraph (e)(2)(iii) of this section.

Example 7.

Corporation U establishes a bonus plan under which a specified class of employees will participate in a bonus pool if certain preestablished performance goals are attained. The amount of the bonus pool is determined under an objective formula. Under the terms of the bonus plan, the compensation committee retains the discretion to determine the fraction of the bonus pool that each employee may receive. The bonus plan does not satisfy the requirements of this paragraph (e)(2). Although the aggregate amount of the bonus plan is determined under an objective formula, a third party could not determine the amount that any individual could receive under the plan.

Example 8.

The facts are the same as in Example 7, except that the bonus plan provides that a specified share of the bonus pool is payable to each employee, and the total of these shares does not exceed 100% of the pool. The bonus plan satisfies the requirements of this paragraph (e)(2). In addition, the bonus plan will satisfy the requirements of this paragraph (e)(2) even if the compensation committee retains the discretion to reduce the compensation payable to any individual employee, provided that a reduction in the amount of one employee's bonus does not result in an increase in the amount of any other employee's bonus.

Example 9.

Corporation V establishes a stock option plan for salaried employees. The terms of the stock option plan specify that no individual salaried employee shall receive options for more than 100,000 shares over any 3-year period. The compensation committee grants options for 50,000 shares to each of several salaried employees. The exercise price of each option is equal to or greater than the fair market value of a share of V stock at the time of each grant. Compensation attributable to the exercise of the options satisfies the requirements of paragraph (e)(2)(vi) of this section. If, however, the terms of the options provide that the exercise price is less than fair market value of a share of V stock at the date of grant, no compensation attributable to the exercise of those options satisfies the requirements of this paragraph (e)(2) unless issuance or exercise of the options was contingent upon the attainment of a preestablished performance goal that satisfies this paragraph (e)(2). If, however, the terms of the plan also provide that Corporation V could grant options to purchase no more than 900,000 shares over any 3-year period, but did not provide a limitation on the number of shares that any individual employee could purchase, then no compensation attributable to the exercise of those options satisfies the requirements of paragraph (e)(2)(vi) of this section.

Example 10.

The facts are the same as in Example 9, except that, within the same 3-year grant period, the fair market value of Corporation V stock is significantly less than the exercise price of the options. The compensation committee reprices those options to that lower current fair market value of Corporation V stock. The repricing of the options for 50,000 shares held by each salaried employee is treated as the grant of new options for an additional 50,000 shares to each employee. Thus, each of the salaried employees is treated as having received grants for 100,000 shares. Consequently, if any additional options are granted to those employees during the 3-year period, compensation attributable to the exercise of those additional options would not satisfy the requirements of this paragraph (e)(2). The results would be the same if the compensation committee canceled the outstanding options and issued new options to the same employees that were exercisable at the fair market value of Corporation V stock on the date of reissue.

Example 11.

Corporation W maintains a plan under which each participating employee may receive incentive stock options, nonqualified stock options, stock appreciation rights, or grants of restricted Corporation W stock. The plan specifies that each participating employee may receive options, stock appreciation rights, restricted stock, or any combination of each, for no more than 20,000 shares over the life of the plan. The plan provides that stock options may be granted with an exercise price of less than, equal to, or greater than fair market value on the date of grant. Options granted with an exercise price equal to, or greater than, fair market value on the date of grant do not fail to meet the requirements of this paragraph (e)(2) merely because the compensation committee has the discretion to determine the types of awards (i.e., options, rights, or restricted stock) to be granted to each employee or the discretion to issue options or make other compensation awards under the plan that would not meet the requirements of this paragraph (e)(2). Whether an option granted under the plan satisfies the requirements of this paragraph (e)(2) is determined on the basis of the specific terms of the option and without regard to other options or awards under the plan.

Example 12.

Corporation X maintains a plan under which stock appreciation rights may be awarded to key employees. The plan permits the compensation committee to make awards under which the amount of compensation payable to the employee is equal to the increase in the stock price plus a percentage “gross up” intended to offset the tax liability of the employee. In addition, the plan permits the compensation committee to make awards under which the amount of compensation payable to the employee is equal to the increase in the stock price, based on the highest price, which is defined as the highest price paid for Corporation X stock (or offered in a tender offer or other arms-length offer) during the 90 days preceding exercise. Compensation attributable to awards under the plan satisfies the requirements of paragraph (e)(2)(vi) of this section, provided that the terms of the plan specify the maximum number of shares for which awards may be made.

Example 13.

Corporation W adopts a plan under which a bonus will be paid to the CEO only if there is a 10% increase in earnings per share during the performance period. The plan provides that earnings per share will be calculated without regard to any change in accounting standards that may be required by the Financial Accounting Standards Board after the goal is established. After the goal is established, such a change in accounting standards occurs. Corporation W's reported earnings, for purposes of determining earnings per share under the plan, are adjusted pursuant to this plan provision to factor out this change in standards. This adjustment will not be considered an exercise of impermissible discretion because it is made pursuant to the plan provision.

Example 14.

Corporation X adopts a performance-based incentive pay plan with a four-year performance period. Bonuses under the plan are scheduled to be paid in the first year after the end of the performance period (year 5). However, in the second year of the performance period, the compensation committee determines that any bonuses payable in year 5 will instead, for bona fide business reasons, be paid in year 10. The compensation committee also determines that any compensation that would have been payable in year 5 will be adjusted to reflect the delay in payment. The adjustment will be based on the greater of the future rate of return of a specified mutual fund that invests in blue chip stocks or of a specified venture capital investment over the five-year deferral period. Each of these investments, considered by itself, is a predetermined actual investment because it is based on the future rate of return of an actual investment. However, the adjustment in this case is not based on predetermined actual investments within the meaning of paragraph (e)(2)(iii)(B) of this section because the amount payable by Corporation X in year 10 will be based on the greater of the two investment returns and, thus, will not be based on the actual rate of return on either specific investment.

Example 15.

The facts are the same as in Example 14, except that the increase will be based on Moody's Average Corporate Bond Yield over the five-year deferral period. Because this index reflects a reasonable rate of interest, the increase in the compensation payable that is based on the index's rate of return is not considered an impermissible increase in the amount of compensation payable under the formula.

Example 16.

The facts are the same as in Example 14, except that the increase will be based on the rate of return for the Standard & Poor's 500 Index. This index does not measure interest rates and thus does not represent a reasonable rate of interest. In addition, this index does not represent an actual investment. Therefore, any additional compensation payable based on the rate of return of this index will result in an impermissible increase in the amount payable under the formula. If, in contrast, the increase were based on the rate of return of an existing mutual fund that is invested in a manner that seeks to approximate the Standard & Poor's 500 Index, the increase would be based on a predetermined actual investment within the meaning of paragraph (e)(2)(iii)(B) of this section and thus would not result in an impermissible increase in the amount payable under the formula.

(3)Outside directors -

(i)General rule. The performance goal under which compensation is paid must be established by a compensation committee comprised solely of two or more outside directors. A director is an outside director if the director -

(A) Is not a current employee of the publicly held corporation;

(B) Is not a former employee of the publicly held corporation who receives compensation for prior services (other than benefits under a tax-qualified retirement plan) during the taxable year;

(C) Has not been an officer of the publicly held corporation; and

(D) Does not receive remuneration from the publicly held corporation, either directly or indirectly, in any capacity other than as a director. For this purpose, remuneration includes any payment in exchange for goods or services.

(ii)Remuneration received. For purposes of this paragraph (e)(3), remuneration is received, directly or indirectly, by a director in each of the following circumstances:

(A) If remuneration is paid, directly or indirectly, to the director personally or to an entity in which the director has a beneficial ownershipinterest of greater than 50 percent. For this purpose, remuneration is considered paid when actually paid (and throughout the remainder of that taxable year of the corporation) and, if earlier, throughout the period when a contract or agreement to pay remuneration is outstanding.

(B) If remuneration, other than de minimis remuneration, was paid by the publicly held corporation in its preceding taxable year to an entity in which the director has a beneficial ownershipinterest of at least 5 percent but not more than 50 percent. For this purpose, remuneration is considered paid when actually paid or, if earlier, when the publicly held corporation becomes liable to pay it.

(C) If remuneration, other than de minimis remuneration, was paid by the publicly held corporation in its preceding taxable year to an entity by which the director is employed or self-employed other than as a director. For this purpose, remuneration is considered paid when actually paid or, if earlier, when the publicly held corporation becomes liable to pay it.

(iii)De minimis remuneration -

(A)In general. For purposes of paragraphs (e)(3)(ii)(B) and (C) of this section, remuneration that was paid by the publicly held corporation in its preceding taxable year to an entity is de minimis if payments to the entity did not exceed 5 percent of the gross revenue of the entity for its taxable year ending with or within that preceding taxable year of the publicly held corporation.

(B)Remuneration for personal services and substantial owners. Notwithstanding paragraph (e)(3)(iii)(A) of this section, remuneration in excess of $60,000 is not de minimis if the remuneration is paid to an entity described in paragraph (e)(3)(ii)(B) of this section, or is paid for personal services to an entity described in paragraph (e)(3)(ii)(C) of this section.

(iv)Remuneration for personal services. For purposes of paragraph (e)(3)(iii)(B) of this section, remuneration from a publicly held corporation is for personal services if -

(A) The remuneration is paid to an entity for personal or professional services, consisting of legal, accounting, investment banking, and management consulting services (and other similar services that may be specified by the Commissioner in revenue rulings, notices, or other guidance published in the Internal Revenue Bulletin), performed for the publicly held corporation, and the remuneration is not for services that are incidental to the purchase of goods or to the purchase of services that are not personal services; and

(B) The director performs significant services (whether or not as an employee) for the corporation, division, or similar organization (within the entity) that actually provides the services described in paragraph (e)(3)(iv)(A) of this section to the publicly held corporation, or more than 50 percent of the entity's gross revenues (for the entity's preceding taxable year) are derived from that corporation, subsidiary, or similar organization.

(v)Entity defined. For purposes of this paragraph (e)(3), entity means an organization that is a sole proprietorship, trust, estate, partnership, or corporation. The term also includes an affiliated group of corporations as defined in section 1504 (determined without regard to section 1504(b)) and a group of organizations that would be an affiliated group but for the fact that one or more of the organizations are not incorporated. However, the aggregation

Источник: https://www.law.cornell.edu/cfr/text/26/1.162-27

17.8 Tax deduction limitations related to compensation

The tax deduction that an employer is eligible for under IRC Section 83(h) may be subject to certain limitations. One limitation is the "million-dollar" limitation, established by IRC Section 162(m) (as amended by the Tax Cuts and Jobs Act of 2017), which provides that, for public companies, the annual compensation paid to individual covered employees in excess of $1 million during the taxable year is not tax deductible. All individuals who hold the position of either chief executive officer or chief financial officer at any time during the taxable year are covered employees. Covered employees also include the company's three other most highly-compensated officers, pursuant to the SEC's rules for executive compensation disclosures in the annual proxy statement. Any individual who is deemed a covered employee will continue to be a covered employee for all subsequent taxable years (i.e., they remain a covered person indefinitely).

If annual compensation includes both cash compensation and stock-based-compensation, a company should first assess whether or not a covered employee's compensation will be subject to the Section 162(m) limitation. The anticipated effect of the Section 162(m) limitation should be considered using one of three methods (as discussed below) when recognizing deferred tax assets for awards that may be subject to the limitation. The selection of a method is an accounting policy that should be applied consistently.

We believe that any of the following approaches, if followed consistently, would be acceptable for determining whether a deferred tax asset should be recorded for stock-based compensation that is subject to the IRC Section 162(m) limitation:

  • The impact of future cash compensation takes priority over stock-based-compensation awards. For example, if the anticipated cash compensation is equal to or greater than the total tax-deductible annual compensation amount for the covered employee, an entity would not record a deferred tax asset associated with any stock-based-compensation cost for that individual.
  • The impact of the stock-based compensation takes priority over future cash compensation and a deferred tax asset would be recorded for the stock-based compensation up to the tax deductible amount.
  • Prorate the anticipated benefit of the tax deduction between cash compensation and stock-based compensation and reflect the deferred tax asset for the stock-based-compensation award based on a blended tax rate that considers the anticipated future limitation in the year such temporary difference is expected to reverse.

Example TX 17-3 illustrates accounting for the tax effects of awards that may be subject to the IRC Section 162(m) limitation.

EXAMPLE TX 17-3
IRC section 162(m) limitations

Company USA enters into a three-year employment contract with its CEO, who is a “covered employee” as defined by IRC Section 162(m). The terms of the contract include $1 million of cash compensation to be paid annually. Additionally, 100,000 shares of non-vested restricted stock are granted in year 1 and cliff vest in two years (i.e., the restricted stock will vest and become tax deductible on the first day of year 3). The fair value of the stock on the grant date is $10 per share for a total fair value of $1 million. Assume the fair value of the stock remains constant and the applicable tax rate is 25%.

How would Company USA account for the tax effects of awards that may be subject to the IRC Section 162(m) limitation?

Analysis

As the restricted stock does not vest until Year 3, CEO’s compensation in years 1 and 2 are not subject to the limitation (it does not exceed $1 million). In year 3, the total compensation for tax purposes would be the $1 million cash compensation and the $1 million in restricted stock, which the CEO will be deemed to have received based on vesting. The deferred tax analysis under each of the three methods is as follows:

(1) Cash compensation takes priority – Available tax deductions are first allocated to cash compensation. As the $1 million in cash compensation would fully absorb the Section 162(m) limitation in year 3, the entire $1 million of stock-based compensation would be considered non-deductible. As a result, the stock-based compensation would not give rise to a temporary difference and no DTA should be recognized. The effective tax rate would be higher in years 1 and 2 under this approach as the book stock-based compensation charge would have no associated deduction for tax purposes.

(2) Stock-based compensation takes priority – Available tax deductions are first allocated to stock-based compensation. As the $1 million in stock-based compensation would be fully deductible under the Section 162(m) limitation in year 3, the stock-based compensation recorded for book purposes in Years 1 and 2 ($500,000 per year) would give rise to a temporary difference, and a DTA should be recognized. The cash compensation in year 3 would be considered non-deductible. The effective tax rate would be normal in years 1 and 2 and would increase significantly in year 3 (as a result of the non-deductibility of $1 million in cash compensation).

(3) Pro rata allocation between cash and stock compensation – Available tax deductions would be allocated between cash compensation and stock-based compensation on a pro rata basis. As both cash compensation and stock-based compensation are expected to be $1 million in Year 3 (total compensation of $2 million), the available $1 million of tax deductions would be allocated 50:50. Thus, while the stock-based compensation recognized for book purposes in Years 1 and 2 would give rise to a temporary difference, only 50% of the total compensation would be recognized as a deferred tax asset. Therefore, the deferred tax benefit in Year 1 ($500,000 × 50% × 25% = $62,500) and Year 2 ($500,000 × 50% × 25% = $62,500) result in a total DTA at the end of Year 2 of $200,000. The $125,000 DTA would reverse in Year 3 when the stock-based compensation is deducted on the tax return.

Источник: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/income_taxes/income_taxes__16_US/chapter_17_income_ta_US/178_tax_deduction_li_US.html

Section 162(m) Compliance Alert - Do You Need to Seek Shareholder Approval of Your Incentive Plan in 2014?

Annual Reminder - If the corporation’s equity or annual incentive plan was last approved by shareholders in 2009, the plan(s) must be submitted to shareholders for re-approval in 2014 in order to ensure that future awards qualify as performance-based compensation under Section 162(m).

Compensation paid by a publicly-traded corporation to its CEO and three other highest compensated officers (other than the Principal Financial Officer) is generally not deductible to the extent it exceeds $1,000,000 per year. This limitation, however, does not apply to qualified performance-based compensation that complies with the requirements of Section 162(m).

There are numerous conditions that must be satisfied for awards to be considered performance-based compensation. Recent IRS audit activity in this area continues to reveal a number of common failures, including: (i) making mid-year changes to performance goals; (ii) making adjustments to the performance goals that were not pre-determined (e.g., adjusting for subsequent events); (iii) failing to obtain shareholder re-approval of the plan; (iv) paying awards out upon retirement or an involuntary termination regardless of whether the performance goals were satisfied; (v) using performance measures that are not included in the shareholder approved plan; (vi) paying out the compensation before the compensation committee certifies in writing that the performance goals were obtained; and (vii) issuing stock options in excess of plan limits.

In an effort to assist employers in their compliance efforts, set forth below are a few action items that employer’s should consider in order to enhance compliance.

What Can Employers Do to Enhance Compliance With Section 162(m)?

Shareholder Re-Approval of 2009 Plans: Where a plan allows the compensation committee to establish the performance goals and targets from year to year (as many plans commonly do), Section 162(m) requires that the performance goals be disclosed and re-approved by shareholders every five years. If the corporation’s equity or annual incentive plan was last approved by shareholders in 2009, the plan(s) must be submitted to the shareholders for re-approval in 2014 in order to ensure that future awards qualify as performance-based compensation under Section 162(m).

Review Proxy Disclosures: Plaintiffs’ attorneys continue to bring derivative suits against corporations and their boards challenging the corporation’s compliance with Section 162(m). The lawsuits allege, among other claims, that (i) the corporation failed to comply with the procedural requirements of Section 162(m), and (ii) the corporation’s proxy contained false and misleading statements by failing to disclose that awards violated the terms of the plan and/or did not qualify as performance-based compensation. Corporations should carefully review their proxy disclosures to ensure that they do not suggest or imply that the corporation’s plan and awards will qualify as performance-based compensation under Section 162(m). The use of language such as “may comply” or “is intended to comply” may protect the corporation from allegations of false or misleading statements in the proxy materials. Additionally, disclosures for shareholder approval or re-approval of a plan should be rigorously reviewed to ensure that they are drafted in compliance with the requirements of Section 162(m).

Update/Establish Grant Procedures: Several recent targets of derivative suits contain Section 162(m) claims involving the issuance of equity or incentive awards in excess of the plan’s specified limits. In several cases where the plan’s limits were exceeded, the Company and the executive agreed to rescind the grants that exceeded the limit in order to avoid the costs and distraction of litigation. Therefore, corporations should establish and/or update grant procedures to ensure that awards are made in compliance with the plan’s terms and that award limits are properly monitored.

Appoint a Section 162(m) Compliance Administrator: In light of the technical nature of Section 162(m), corporations should consider designating a compliance administrator in the corporation’s tax or legal department to assume overall responsibility for monitoring compliance with Section 162(m) and the corporation’s established grant procedures. The compliance administrator should be authorized to attend compensation committee meetings, and otherwise be given access to the corporation’s compensation, tax and legal advisors as necessary to carry out his or her responsibilities.

Источник: https://www.bipc.com/

On Dec. 22, President Trump signed into law the 2017 Tax Act, the most comprehensive set of changes to the Internal Revenue Code since 1986. Some of the changes affect executive compensation and employee benefits. Because many of the provisions take effect in 2018, employers should begin evaluating their potential impact as soon as possible.

It is important to note that the employee benefits and executive compensation changes in the 2017 Tax Act are not as sweeping as they could have been. For example, proposals for limiting retirement plan contributions did not make their way into the 2017 Tax Act, and a major proposed revision to the taxation of nonqualified deferred compensation was dropped before the legislation was finalized. (For reference, the 2017 Tax Act is P.L. 115-97. The proposed short title for the Act, the “Tax Cut and Jobs Act,” was dropped before enactment on procedural grounds.) While some of the proposals did not find their way into the final 2017 Tax Act, they are discussed briefly below because they could resurface at some point.

Executive Compensation

  • Modification of Deduction Limit on Compensation for Public Company Executives: The 2017 Tax Act repeals the exception to the Internal Revenue Code Section 162(m) $1 million deduction limitation for commission and performance-based compensation paid to a covered employee of a publicly traded corporation. This exception currently applies to compensation payable to covered employees defined to include the chief executive officer (CEO) and the three other highest-compensated officers, but excluding the chief financial officer (CFO). The 2017 Tax Act revises the definition of covered employee to include the CFO.

The 2017 Tax Act also expands the categories of public companies subject to the deduction limitation. Currently, Section 162(m) applies only to companies with a registered class of securities. Going forward, it also will apply to any company that is required to file public reports with the Securities and Exchange Commission (SEC).

The 2017 Tax Act also provides that, starting with those persons who are covered employees for 2017, once an officer becomes a covered employee, he or she remains a covered employee forever.  This means that deferred compensation still would be subject to the $1 million deduction limitation even if paid in a year after the officer ceases to be CEO, CFO or one of the top-paid officers. The 2017 Tax Act treats beneficiaries of covered employees as covered employees for this purpose. Effective Date — applies for tax years beginning after Dec. 31, 2017. However, compensation paid pursuant to a written binding agreement in effect on Nov. 2, 2017, that has not been materially modified thereafter is grandfathered and can continue to qualify for the performance-based compensation exemption, assuming all other Section 162(m) requirements are met.

Practice Note: Companies should review incentive plan documents and policies to determine what changes may be necessary to reflect the new Section 162(m) rules. Compensation committee charters and directors and officers liability insurance (D&O) questionnaires also should be reviewed and revised, if necessary. Compensation discussion and analysis sections (CD&As) for 2018 proxy statements should be reviewed to determine if any changes are advisable related to the Section 162(m) discussion. Companies should catalog grandfathered arrangements and implement processes to ensure that such arrangements are not unintentionally materially modified. Companies should also re-examine incentive compensation plan designs in light of the new Section 162(m) rules (including equity grant design and practices), as the new rules offer significant new flexibility and, at the same time, may make some practices (such as stock options) less attractive than before.

  • New Tax on Excessive Executive Compensation Paid by Tax-Exempt Organizations: The 2017 Tax Act imposes a 21 percent tax on most tax-exempt organizations — including most state governmental organizations and political subdivisions thereof — on compensation in excess of $1 million and any golden parachute compensation paid to the organization’s covered employees, defined to include the five highest-paid executives for the current taxable year or any preceding year after 2016. The tax is imposed on the organization, not the employee (which would have been the case under earlier versions of this provision).

The provision takes into account all W-2 wages paid to any such executive in a taxable year, excluding designated Roth contributions under qualified retirement plans, but specifically including wages under a Section 457(f) deferred compensation plan. There is no grandfathering rule in the 2017 Tax Act for existing arrangements, although the Treasury Department and IRS may consider adding such a rule when implementing regulations are developed.

For purposes of the tax on excess golden parachute payments, an excess parachute payment generally includes a payment contingent on the executive’s separation from employment with an aggregate present value of at least three times the executive’s base compensation. Similar to existing golden parachute rules for taxable organizations under Section 280G, the base amount is equal to the executive’s trailing five-year average W-2 compensation. Effective Date — applies for tax years beginning after Dec. 31, 2017.

Practice Note: Covered tax-exempt organizations should determine who their covered executives are and begin cataloging executive compensation arrangements for those officers to determine if and when the tax imposed by the 2017 Tax Act would apply. This may include employment agreements, Section 457(f) deferred compensation plans, severance agreements, and annual or long-term incentive arrangements, in addition to salary and taxable benefits. Organizations should also monitor regulatory developments, as the IRS is likely to offer significant interpretive guidance under the statute when it issues regulations. Since the golden parachute tax rules are designed to track the existing golden parachute tax rules for taxable entities under Section 280G, organizations may want to familiarize themselves with those rules or seek guidance from outside experts already familiar with the Section 280G provisions.

  • Qualified Equity Grants: The 2017 Tax Act offers a significant new tax planning opportunity for private companies that widely distribute stock options or stock-settled restricted stock units (RSUs) to their employees.

If a company distributes stock options or RSUs to at least 80 percent of its U.S. employees (determined on a controlled group basis), an employee (other than a 1 percent shareholder, the CEO or CFO or one of the top four most highly compensated officers at any time during the current or previous 10 years) can elect to defer the income tax associated with the stock option exercise or RSU settlement for up to five years after the option exercise or RSU settlement date. If the stock delivered upon option exercise or RSU settlement is unvested and nontransferable, the employee can defer the tax for up to five years after the stock vests or becomes transferable. The amount of income tax will be based on the value of the shares at the time of option exercise or RSU settlement (or at the time of vesting or transferability, if later). Options or RSUs granted after 2017 must have the same rights and privileges (other than grant size, provided that each employee receives more than a de minimis grant) to qualify for this rule. 

The provision applies only to corporations, not limited liability companies taxed as partnerships, and only to grants made to employees. In addition, the favorable tax treatment does not apply if the stock is transferable when it is issued, — including to the employer. An employer is required to give notice to an employee who is issued qualified employer stock and the employee has 30 days after receiving the stock to make the election and may revoke the election at any time. The new rule applies in addition to (and does not supersede) the existing Section 83(b) election regime and the rules relating to qualified stock options (incentive stock options or ISOs, and employee stock purchase plans) — however, the rules cannot be combined. For example, if an employee elects to take advantage of the new rules with respect to an ISO, the ISO treatment ends. Effective Date — applies to stock options exercised or RSUs settled after Dec. 31, 2017.

Practice Note: The new rules offer a potential planning tool around the existing problem with employees of private corporations having to pay income taxes on illiquid shares they receive from incentive awards. However, the requirement that companies have to issue awards to at least 80 percent of their employees may make the new rules unattractive for many companies and relatively limited in application. For a certain type of private company, however, that broadly issues equity awards to its employees or is contemplating doing so, these rules are worth serious consideration.

Retirement Plans and Individual Retirement Accounts (IRAs)

  • Longer Period for Rollover of Certain Plan Loan Offsets: The 2017 Tax Act extends the time period in which employees, whose plans terminate or who separate from employment with outstanding plan loans, may contribute an amount equal to the unpaid balance of such loans to an IRA to avoid that amount being treated as a distribution to the employee. A plan loan is considered outstanding until it is repaid or “offset.” Offset occurs when the participant’s remaining plan balance is used to repay the loan, thus resulting in a deemed distribution to the participant of the repaid loan amount. Deemed distribution can be avoided if the participant’s plan benefits are eligible for rollover and an amount equal to the offset amount is included in the rollover. Previously, such amounts could only be rolled over to an IRA during the 60-day period beginning on the date offset occurred. The 2017 Tax Act extends the deadline for rollover to the due date of the employee’s tax return for the year the plan terminated or the employee separated from employment (as applicable). Effective Date — applies to loan offsets that arise in tax years beginning after Dec. 31, 2017.

Practice Note: Employers that sponsor plans allowing for loans should consider whether plan participant communications should be revised early next year to alert participants to the greater flexibility allowable for rollover of loan offset amounts.

  • Repeal of Roth IRA Recharacterizations: The 2017 Tax Act repeals a special rule permitting recharacterization of Roth IRA contributions or conversions as instead having been made to traditional IRA amounts. As a result, a popular technique to unwind Roth IRA conversions will cease to be available. The 2017 Tax Act keeps in place provisions allowing for recharacterization of other contributions, thereby continuing to allow recharacterization of a Roth IRA contribution as a contribution to a traditional IRA. Effective Date — applies for tax years beginning after Dec. 31, 2017. 
  • Length of Service Award Programs for Public Safety Volunteers: Section 457 provides special tax treatment for certain programs designed to benefit public service volunteers (i.e., those who provide firefighting, emergency medical and ambulance services). The maximum annual benefit limit for such programs is increased under the 2017 Tax Act from $3,000 to $6,000, subject to adjustment for cost-of-living increases.  Effective Date — applies for tax years beginning after Dec. 31, 2017.

Other Employer-Provided Benefits

  • Qualified Moving Expenses: Employers now will be precluded from reimbursing employees on a tax-free basis for eligible moving expenses (except for certain moves by members of the armed services). Effective Date — applies for tax years 2018 to 2025.
  • Employee Achievement Awards: Certain awards granted to employees in recognition of length of service or safety achievement are not taxable to the employee and are deductible by the employer. The 2017 Tax Act clarifies that the following types of awards do not qualify for this special tax treatment: cash, cash equivalents, gift cards, gift coupons or gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of such items preselected or preapproved by the employer), vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items. Effective Date — applies to amounts paid or incurred after Dec. 31, 2017.
  • Individual Mandate Tax Penalty Under the Affordable Care Act (ACA): The 2017 Tax Act effectively repeals the tax penalty assessed on individuals for not obtaining health coverage by reducing the penalty to zero. Effective Date — applies for months beginning after Dec. 31, 2018.

Practice Note: Changes to ACA rules that directly affect employer-provided health coverage were not enacted, such as the employer mandate and the so-called “Cadillac Tax” on high-value health plans. Because the employer mandate remains in effect, covered employers must continue to offer health coverage in order to avoid penalties. However, the effective repeal of the individual mandate may result in reduced enrollment through the ACA exchange and thereby reduce potential exposure for some employers to employer mandate penalties. In addition, the repeal of the individual mandate may provide increased initiative for later legislative action to modify or repeal the employer mandate.

  • Qualified Transportation Benefits: Employees are not taxed on and employers may deduct the cost of “qualified transportation fringes” (i.e., certain commuting and parking benefits). Under the 2017 Tax Act, employers can continue to provide qualified transportation fringes to employees on a tax-free basis, except for bicycle commuter reimbursements. Employers will no longer be able to deduct the cost of any qualified transportation fringe. Effective Date — the repeal of the exclusion for bicycle commuter reimbursement applies for tax years 2018 to 2025. The elimination of the employer deduction for all qualified transportation fringes applies to amounts paid or incurred for tax years beginning after Dec. 31, 2017.
  • Expenses for Entertainment and Meals: Under prior law, employers were generally permitted to deduct up to 50 percent of entertainment and meal expenses directly connected to a business activity. In addition, employers generally could deduct meals furnished on premises for their convenience. The 2017 Tax Act eliminates the deduction for entertainment expenses. The deduction for meal expenses (subject to the same prior law 50 percent limit) remains in effect, as does the deduction for meals provided for the convenience of the employer (but only until 2025). Effective Date — applies to amounts paid or incurred for tax years beginning after Dec. 31, 2017.  The repeal of the deduction for meals provided at the convenience of the employer will apply to amounts paid or incurred after Dec. 31, 2025.
  • Certain Fringe Benefits Provided by Tax-Exempt Employers: The 2017 Tax Act creates new rules requiring tax-exempt employers to be taxed on the value of qualified transportation fringes, on-premises gyms and other athletic facilities they provide to their employees. The value of those benefits will now be treated as unrelated taxable income.  Effective Date — applies to amounts paid or incurred for tax years beginning after Dec. 31, 2017.
  • New Tax Credit for Paid Leave: Employers will be eligible for a business tax credit equal to 12.5 percent to 25 percent of the wages they pay to certain employees on qualified family and medical leave. To be eligible, an employer must pay employees on leave at least 50 percent of their hourly rate of pay (or a prorated amount for those not paid hourly) and must provide at least two weeks of paid leave per year. The amount of the credit increases by a quarter of a percent for every percent above the minimum 50 percent rate of pay and is capped at 25 percent for leave pay equal to 100 percent of regular pay. Effective Date — applies to tax years 2018 and 2019.

Significant Reform Proposals Not Contained in the 2017 Tax Act

Unlike earlier versions of tax reform, the 2017 Tax Act does not alter the existing tax rules for nonqualified deferred compensation plans under Section 409A. These complex rules, which expose employees to severe adverse tax consequences if nonqualified arrangements fail to comply in form or operation, will continue to apply to such arrangements going forward. The existing tax regime for nonqualified arrangements of tax-indifferent entities under Section 457A also remain in place.

Despite early indications that tax reform might spell doom for the existing favorable tax regime for equity awards in the form of “profits interests” granted to individuals performing services for a partnership or a limited liability company taxed as a partnership, the 2017 Tax Act leaves the existing profits interest regime mostly intact. It changes only the holding period, from one year to three years, for profits interests to qualify for long-term capital gains treatment, and then only for a capital-raising or investment-related trade or business.

Early versions of the 2017 Tax Act targeted for repeal the tax exclusion for a number of popular employer-provided benefits, such as qualified educational assistance, dependent care assistance and adoption assistance programs. None of those proposals were enacted.

For further information about the 2017 Tax Act and the considerations noted above, please contact any of the members of the McGuireWoods employee benefits and executive compensation team.

Источник: https://www.mcguirewoods.com/client-resources/Alerts/2017/12/New-Tax-Rules-Executive-Compensation-Employee-Benefits

December 22, 2020
2020-2923

Final IRC Section 162(m) regulations have few changes

The IRS published final regulations under IRC Section 162(m) (TD 9932), incorporating Tax Cuts and Jobs Act (TCJA) statutory amendments and making certain other changes to existing rules. The final rules generally follow the proposed rules previously published in December 2019, but there are a few key changes:

  • Additional transition relief for a publicly held corporation's distributive share of the deduction for compensation paid by a partnership on or before December 18, 2020 (common in an "Up-C" or "Up-REIT" structure)
  • A simplified approach for calculating grandfathered amounts of deferred compensation subject to pre-TCJA rules, making it unnecessary to track losses on amounts deferred as of November 2, 2017
  • A different approach to clawbacks, such that the right to recover compensation after it is paid does not affect its grandfathered status
  • Clarification that extending the exercise period for a grandfathered stock option or stock appreciation right is not a material modification and does not cause a loss of grandfathered status

The final regulations also include other, less significant new rules and clarifications.

The final regulations generally apply to tax years beginning on or after the date the regulations are published in the Federal Register, although a taxpayer may choose to apply them to tax years beginning after December 31, 2017, if the taxpayer applies them in their entirety and in a consistent manner. There are special applicability dates for some rules, most of which were included in the proposed regulations.

Background

IRC Section 162(m) imposes a $1 million limit on the deduction that a "publicly held corporation" is allowed for compensation paid with respect to a "covered employee." IRC Section 162(m) was originally enacted as part of the Omnibus Budget Reconciliation Act of 1993 (OBRA 1993), effective for tax years beginning on or after January 1, 1994. Comprehensive final regulations were published in 1995 (1995 Regulations).

As originally enacted, IRC Section 162(m) defined a "covered employee" as the CEO and the next four highest-compensated officers whose compensation was required to be reported to shareholders under the Securities Exchange Act of 1934 (Exchange Act). When the SEC rules were later amended to require disclosure for the CEO, the CFO and the three highest-compensated officers other than the CEO and the CFO, the IRS concluded that there would be only four "covered employees" in most cases: the CEO and the three highest-compensated officers other than the CEO and the CFO.1 For all "covered employees," the 1995 Regulations imposed a "last day" requirement: compensation (such as severance and deferred compensation) paid to an individual who was no longer a covered employee on the last day of the corporation's tax year was not subject to the $1 million deduction limit.

Only publicly held companies that were required to register their common stock under Section 12 of the Exchange Act were subject to IRC Section 162(m) as it was originally enacted. It did not apply to companies that registered debt, voluntarily registered their common stock or were foreign private issuers traded on US exchanges via American Depository Receipts (ADRs). Moreover, IRC Section 162(m) originally contained a significant exception for performance-based compensation, including cash and stock-based compensation contingent upon the attainment of objective performance goals and meeting other requirements, as well as for most stock options and stock appreciation rights.

The TCJA made several amendments to IRC Section 162(m) to expand its applicability, including:

  • Eliminating the exception for performance-based compensation
  • Expanding the definition of "covered employee" to include the CFO, plus any individual who had ever been a covered employee of the publicly held corporation or any predecessor for any tax year beginning after December 31, 2016 (thus, under the TCJA amendments, once an individual is identified as a covered employee, the deduction limitation applies to the compensation paid to that individual even after the individual no longer holds that position or has separated from service)
  • Expanding the definition of "publicly held corporation" to include certain companies to the extent those companies must report under Section 15(d) of the Exchange Act, including foreign private issuers or private companies that have registered debt offerings

All of these amendments were generally effective for tax years beginning after December 31, 2017, but under a grandfather rule any compensation paid pursuant to a written binding contract that was in effect on November 2, 2017, and not materially modified on or after that date, remains subject to IRC Section 162(m) as it existed prior to the TCJA amendments.

In August 2018, the IRS and Treasury released Notice 2018-68 with guidance on a limited number of issues arising under the TCJA amendments. With respect to the definition of "covered employee," the Notice confirmed that the "last day" rule that applied under the 1995 Regulations was eliminated and, therefore, the compensation of a covered employee may be subject to IRC Section 162(m) in some cases even though it is not subject to disclosure under the SEC rules. The Notice also clarified various aspects of the grandfather rule, generally applying analogous transition rules from the 1995 Regulations (see Tax Alert 2018-1679 for a more detailed description of Notice 2018-68).

Rather than amending the 1995 Regulations to reflect the TCJA amendments, the proposed regulations provided a separate, comprehensive set of rules (see Tax Alert 2019-2229). (The 1995 Regulations continue to apply to grandfathered amounts.) The proposed regulations included: (1) rules related to the TCJA amendments (only some of which were contained in Notice 2018-68); (2) new rules completely unrelated to the TCJA amendments; and (3) certain existing rules carried over from the 1995 Regulations. The proposed regulations also included more than 80 examples.

Analysis of the Final Regulations

The following sections of this Alert highlight the key rules and definitions set forth in the proposed regulations that were either retained or modified in the final regulations.

Definition of publicly held corporation

Proposed regulations

Like the 1995 Regulations, the proposed regulations looked to the last day of the corporation's tax year to determine its status as a publicly held corporation. The proposed regulations, however, reflected the TCJA amendments under which a corporation is considered publicly held if any of its securities are required to be registered under Section 12 of the Exchange Act or the corporation is required to file reports under Section 15(d) of the Exchange Act. Under the proposed regulations, a corporation was not considered publicly held while its obligation to file reports under Section 15(d) was suspended. The proposed regulations also clarified that a subsidiary of a publicly held corporation was itself a publicly held corporation and separately subject to IRC Section 162(m) under the affiliated group rules discussed below.

Citing the TCJA amendments and legislative history, the proposed regulations rejected a commenter's suggestion that foreign private issuers be exempt from IRC Section 162(m). The proposed regulations did, however, recognize that a safe harbor for these corporations may be appropriate, given that they are not subject to the SEC executive compensation disclosure rules and thus may incur undue burdens identifying their covered employees.

The proposed regulations generally retained the 1995 Regulations' rules for affiliated groups of corporations. Under those rules, a publicly held corporation included an affiliated group of corporations as defined in IRC Section 1504 (without regard to IRC Section 1504(b)), but each publicly held subsidiary and its subsidiaries (if any) were separately subject to IRC Section 162(m). The proposed regulations included a new rule under which IRC Section 162(m) would apply to a privately held parent corporation with a publicly held subsidiary. The proposed regulations also expanded on the 1995 Regulations' rules for prorating the deduction disallowance among the members of an affiliated group.

The proposed regulations included a new rule for disregarded entities. If a disregarded entity owned by a privately held corporation was an issuer of securities required to be registered under Sections 12(b) or 15(d) of the Exchange Act, the proposed regulations treated the otherwise privately held corporation as a publicly held corporation for purposes of IRC Section 162(m). The proposed regulations included a similar rule for QSubs (certain wholly owned subsidiaries of S corporations).

Final regulations

The final regulations retain the rules from the proposed regulations. Under a new rule, consistent with the proposed rule for QSubs, a real estate investment trust (REIT) that owns a qualified real estate investment trust subsidiary (QRS) is a publicly held corporation if the QRS issues securities required to be registered under Section 12(b) of the Exchange Act or is required to file reports under Section 15(d) of the Exchange Act. There is no safe harbor for identifying covered employees of foreign private issuers in the final regulations because none was proposed by commenters.

The final regulations modify an example involving the application of IRC Section 162(m) in the case of an individual who is a covered employee for only two of the three publicly held corporations in an aggregated group but who is paid compensation by all three. (This was Example 2 in the proposed regulations, but it is Example 20 in the final regulations.) The aggregate compensation paid by the three corporations is $3 million, and the final regulations conclude that the total deduction disallowance is $1 million, as one might expect. The example in the proposed regulations had concluded that the aggregate deduction disallowance was $1.6 million, which resulted from an allocation method that required double counting of amounts over the $1 million limit. This change was made in response to a comment criticizing the double counting.

Definition of covered employee

Proposed regulations

The proposed regulations generally followed the methodology for identifying covered employees that was set forth in Notice 2018-68. The IRS and Treasury declined to adopt some comments requesting simplification.

Notice 2018-68 did not address how to identify the three most highly-compensated executive officers if the corporation's fiscal year and tax year did not align, such as when the corporation has a full 12-month fiscal year but a short tax year. Under the proposed regulations, the SEC executive compensation disclosure rules would be applied as if the relevant tax year (a short tax year, for example) were the corporation's fiscal year. This rule was proposed to apply to tax years beginning on or after the publication of the proposed regulations in the Federal Register (December 20, 2019).

Notice 2018-68 also did not address how to identify the predecessor of a publicly held corporation for purposes of the rule that treats an individual as a covered employee if the individual was a covered employee of the publicly held corporation or any predecessor corporation for any tax year beginning after December 31, 2016. The proposed regulations supplied rules for a variety of corporate transactions: reorganizations, divisions, stock acquisitions and asset acquisitions. These rules were proposed to apply to corporate transactions for which all events necessary for the transaction occurred on or after the date the final regulations were published in the Federal Register. The proposed regulations also would treat a corporation as its own predecessor if it went from being publicly held to being privately held and then back to being publicly held again within a three-year period (if the corporation became publicly held again on or after the final regulations were published in the Federal Register). For the period prior to publication of the final regulations, the proposed regulations permitted reliance on the proposed rule, or any reasonable, good faith interpretation of the term "predecessor," and defined certain examples of what would not represent a reasonable, good faith interpretation.

The proposed regulations also treated employees of disregarded entities and QSubs as covered employees of their corporate owners if those employees were executive officers of the corporate owners under the SEC rules.

Final regulations

The final regulations retain the rules from the proposed regulations, with certain minor additions and clarifications. The final regulations provide rules for identifying the covered employees of a REIT that owns a QRS. The final regulations also clarify that for purposes of determining the predecessor of a publicly held corporation in the context of an asset acquisition the 80% threshold for operating assets refers to gross operating assets and not net operating assets.

Definition of applicable employee remuneration

Proposed regulations

The proposed regulations provided that "applicable employee remuneration" (referred to in the proposed and final regulations as "compensation" for simplicity) meant: (1) the aggregate amount allowable as a deduction under chapter 1 of the Code for the tax year; (2) determined without regard to IRC Section 162(m); (3) for compensation for services performed by a covered employee; (4) regardless of whether the services were performed during the tax year. The proposed regulations reiterated that compensation includes an amount that is includible in the income of, or paid to, a person other than a covered employee, including after the death of the covered employee.

Among the most significant new rules in the proposed regulations were the rules for partnerships. These rules were unrelated to the TCJA amendments and were not in the 1995 Regulations. The proposed regulations would have applied IRC Section 162(m) to compensation payments made to a covered employee by a partnership to the extent the IRC Section 162 deduction for that compensation was allocated to a publicly held corporation (or its affiliate) based on the corporation's interest in the partnership. This result was contrary to four private letter rulings2 and would effectively subject "Up-REITs" and businesses with so-called "Up-C" partnership structures (in which a publicly held REIT or corporation, as applicable, holds an interest in a lower-tier operating partnership) to IRC Section 162(m) for the first time. This part of the proposed regulations had a special grandfather rule under which IRC Section 162(m) would not apply to compensation paid pursuant to a written binding contract in effect on the date the proposed regulations were published in the Federal Register (December 20, 2019) and not materially modified after that date.

Under the proposed regulations, IRC Section 162(m) would not be limited to compensation paid to a covered employee for services as an employee, but instead would also include compensation for services the individual rendered as an independent contractor. What's more, the preamble to the proposed regulations asserted that this has been the rule since the enactment of IRC Section 162(m) in 1993. To reach that conclusion the IRS and Treasury relied heavily on the OBRA '93 legislative history, which states: "If an individual is a covered employee for a tax year, the deduction limitation applies to all compensation not explicitly excluded from the deduction limitation, regardless of whether the compensation is for services as a covered employee and regardless of when the compensation was earned." House Conf. Rep. 103-213, 585 (1993).

Final regulations

The final regulations retain the rules from the proposed regulations but provide additional transition relief for a publicly held corporation's distributive share of a partnership's compensation deductions. In addition to grandfathering compensation paid pursuant to a written binding contract in effect on December 20, 2019 (and not materially modified after that date), compensation paid on or before December 18, 2020, is not subject to the partnership rule. This date corresponds to the date the final regulations were available on the IRS website, which precedes the Federal Register publication date.

Some practitioners had wondered whether the final rules would be expanded even further to apply IRC Section 162(m) to compensation paid by a partnership's corporate subsidiaries (commonly found in an "Up-REIT" structure where the operating partnership holds a taxable REIT subsidiary). The Preamble, however, affirms that, "[a]ssuming the partnership is respected for U.S. federal income tax purposes, [IRC S]ection 162(m) generally would not apply to compensation paid to a publicly held corporation's covered employee by a corporate subsidiary of a partnership for services performed as an employee of the subsidiary because, in this circumstance, the corporate subsidiary would not be a member of the publicly held corporation's affiliated group."

IPO transition rule

Proposed regulations

The 1995 Regulations provided a transition rule for a corporation that becomes publicly held. While this rule was not limited to initial public offerings (IPOs), it is commonly known as the "IPO transition rule." The Preamble to the proposed regulations explained that the rationale for this rule was tied to the performance-based compensation exception, which the TCJA eliminated. Under the proposed regulations, the IPO transition rule would not apply to corporations that became publicly held corporations on or after the date the proposed regulations were published in the Federal Register (December 20, 2019). Instead, the proposed regulations specified that a privately held corporation that became publicly held would be subject to IRC Section 162(m) for the tax year ending on or after the date that its registration statement became effective under either the Securities Act or the Exchange Act.

Final regulations

The final regulations retain the rules from the proposed regulations and clarify that a subsidiary that was a member of an affiliated group may continue to rely on the transition rule if it became a separate publicly held corporation on or before December 20, 2019.

Grandfathering

Proposed regulations

The proposed regulations retained all the grandfather rules from Notice 2018-68, including some of the same examples.

Notice 2018-68 made clear that compensation was not grandfathered to the extent the corporation was not obligated under applicable law to pay it as of November 2, 2017. Stated differently, compensation with respect to which the corporation retained negative discretion (that is, the legal right not to pay) was not grandfathered.

Notice 2018-68 did not address discretionary clawbacks — compensation that the corporation could require the covered employee to repay only if certain circumstances arise. Under the proposed regulations, otherwise grandfathered payments would not lose their grandfathered status so long as the corporation's right to demand repayment was based on conditions objectively outside the corporation's control and the conditions giving rise to the corporation's right to demand repayment had not occurred. If the conditions did occur, however, then only the amount the corporation was obligated to pay under applicable law (taking into account the occurrence of the condition) would remain grandfathered.

Notice 2018-68 included numerous examples that focused on defined contribution plans. The proposed regulations clarified that the same basic rule applied to both defined contribution plans and defined benefit plans: only the amount of compensation that the corporation was obligated to pay under applicable law on November 2, 2017, was grandfathered. To illustrate the application of this rule, the proposed regulations included new examples involving defined benefit plans and other types of arrangements, such as "linked plans" (nonqualified deferred compensation plans linked to qualified retirement plans) and severance agreements, as well as earnings on grandfathered amounts.

Under the TCJA, an otherwise grandfathered amount loses its grandfathered status if there is a material modification of the written binding contract on or after November 2, 2017. Drawing heavily from the 1995 Regulations, Notice 2018-68 addressed a number of material modification issues. The proposed regulations retained all the rules from Notice 2018-68. One issue Notice 2018-68 did not address, however, was whether acceleration of vesting would be considered a material modification. Under the proposed regulations, the acceleration of vesting was not treated as a material modification.

Notice 2018-68 also did not address how to identify the grandfathered amount when compensation is paid in a series of payments rather than as a lump sum. Under the proposed regulations, the grandfathered amount would be recovered first, and non-grandfathered amounts would be recognized only after the grandfathered amount was fully recovered.

Final Regulations

The final regulations generally retain the rules from the proposed regulations, but those rules are expressed using fewer illustrative examples and more operative rules. In addition, there are four key changes to the proposed rules.

First, the final regulations have a different rule for clawbacks. As the Preamble explains, "After further consideration, the Treasury Department and the IRS recognize that the corporation's right to recover compensation is a contractual right that is separate from the corporation's binding obligation under the contract (as of November 2, 2017) to pay the compensation. Accordingly, these final regulations provide that the corporation's right to recover compensation does not affect the determination of the amount of compensation the corporation has a written binding contract to pay under applicable law as of November 2, 2017, whether or not the corporation exercises its discretion to recover any compensation in the event the condition arises in the future."

Second, the final regulations include a new rule under which the grandfathered amount is not required to be reduced for losses after November 2, 2017. Tracking grandfathered amounts is simpler under this rule because it is unnecessary to distinguish investment gains and losses from new plan benefits if the value of the grandfathered benefit falls after November 2, 2017.

Third, the final regulations require the grandfathered amount to be determined on a plan-by-plan basis. Thus, for example, if a participant's grandfathered benefit under one plan is forfeited, the grandfathered amount does not become available under another plan — the grandfathered amount associated with the forfeited compensation is simply lost.

Finally, the final regulations add a rule that extending the exercise period for a grandfathered stock option or stock appreciation right is not a material modification and does not cause a loss of grandfathering, provided that the extension complies with Treas. Reg. Section 1.409A-1(b)(5)(v)(C)(1). A common example is an employer allowing a stock option to be exercised for a short time after an employee separates from service, even though the original terms of the stock option called for the exercise period to end upon separation from service.

Applicability dates

Although the final regulations generally apply to tax years beginning on or after the regulations are finalized, there are special applicability dates for certain rules. Where relevant, the special applicability date for each newly proposed rule is identified in the discussion above along with the description of the rule. In addition, the rules contained in Notice 2018-68, nearly all of which were retained in both the proposed and final regulations without substantive changes, apply to tax years beginning on or after September 10, 2018.

The following chart summarizes the final applicability dates:

Rule

Applicability date

Tax year for calendar-year taxpayers

Notice 2018-68 rules for covered employees and grandfathering

Tax years ending on or after September 10, 2018

2018

Identifying three highest compensated executive officers when tax year is different from fiscal year

Tax years ending on or after December 20, 2019

2019

Distributive share of partnership compensation deduction

For compensation paid after December 18, 2020

2020 (for compensation paid December 19-31, 2020 that is not grandfathered)

IPO transition rule repealed

Corporation becomes publicly held after December 20, 2019

Depends on transaction date

Predecessor corporation rules for identifying covered employees

Transactions on or after date of publication in the Federal Register

Depends on transaction date

Public to private to public 36-month cooling off period

Corporation becomes publicly held again on or after date of publication in the Federal Register

Depends on date corporation becomes publicly held again

All other rules

Tax years beginning on or after date of publication in the Federal Register

2021

Implications

Taxpayers likely will be disappointed by the modest changes to the proposed rules. Commenters had suggested numerous changes that would have narrowed the scope of IRC Section 162(m), thereby allowing taxpayers greater compensation deductions. Nearly all those suggestions were rejected.

The most important change in the final regulations is the additional transition relief for a publicly held corporation's distributive share of a partnership's compensation deductions. As proposed, this rule would have applied retroactively once the final regulations were published. The proposed regulations were published in the Federal Register on December 20, 2019, and this rule was proposed to apply to tax years ending on or after that date (2019 in the case of a calendar year taxpayer). This put some taxpayers in an awkward position, because they had to file tax returns without knowing whether this rule would be included in the final regulations and applied retroactively as proposed. In many cases, however, this was a moot point, thanks to the special grandfather rule for amounts paid pursuant to a written binding contract in effect on December 20, 2019. Thus, many taxpayers had been expecting 2020 to be the first year the new partnership rule would have any practical effect. The additional transition relief for amounts paid on or before December 18, 2020, likely will allow those taxpayers to avoid applying the partnership rule for one more year. In many cases, this will mean one more year of avoiding the $1 million deduction limit entirely.

Other favorable changes in the final regulations were more modest. These changes include the simplified approach for calculating grandfathered amounts subject to pre-TCJA rules, making it unnecessary to track losses on amounts deferred as of November 2, 2017; the more reasonable approach to clawbacks; and the clarification that extending the exercise period for a grandfathered stock option or stock appreciation right is not a material modification and does not result in a loss of grandfathering.

If there is a silver lining for tax professionals, it is that the final rules are by and large familiar. Indeed, some of the most important rules in the final regulations were carried forward from Notice 2018-68, which was released more than two years ago.

———————————————

———————————————
ENDNOTES

1 Notice 2007-49. With regard to smaller reporting companies (and emerging growth companies), the SEC rules allow for reduced disclosure, generally consisting of three individuals: the CEO and the two highest-compensated officers other than the CEO. The IRS confirmed in CCA 201543003 that the CFO would be considered a "covered employee" subject to IRC Section 162(m) if the CFO's compensation is required to be disclosed as one of the two highest-compensated officers.

2 PLR 200837024, PLR 200727008, PLR 200725014 and PLR 200614002. Since 2010 this has been an issue on which the IRS will not issue rulings, but taxpayers and their advisors have come to their own views based upon the statutory and regulatory rules in effect.

Источник: https://taxnews.ey.com/news/2020-2923-final-irc-section-162m...

: 162 m limitation and stock options

162 m limitation and stock options
EMBED INSTAGRAM FEED
Chase slate credit card phone number

New 162(m) Guidance: IRS Notice 2018-68 Clarifies Scope of Tax Reform and Transition Rules


Section 162(m) of the Internal Revenue Code denies a tax deduction to a public company for compensation paid to certain individuals—called “covered employees ”—to the extent that the compensation paid to such individual exceeds $1,000,000 for the taxable year.

In 2017, Section 162(m) was amended to, among other things:

  • Expand the definition of a “covered employee”,
  • Expand the definition of a “public company” subject to Section 162(m), and
  • Apply the 162(m) deduction limitation to commission pay and performance-based compensation, which had been previously exempted from the 162(m) deduction limitation.

These 2017 amendments apply to all taxable years beginning on or after January 1, 2018. However, an exception to this rule provides that compensation payable pursuant to written binding contracts in force as of November 2, 2017, will remain subject to the 162(m)deduction limitations that were in effect prior to the 2017 amendments, until such contracts are materially modified (referred to in this client alert as the “grandfathering rule ” and “grandfathered compensation ”). Please see our prior client alert for additional details, “Congress Approves Tax Reform Bill Impacting Equity Compensation.”

On August 21, 2018, the IRS issued Notice 2018-68 which clarified the scope of the 2017 amendments. These clarifications are effective for taxable years ending on or after September 10, 2018. A summary of key points follows:

  • Covered Employees Interpreted Broadly. The 2017 amendments expanded the definition of a “covered employee” to include an employee of a public company who:
    1. Served as the principal executive officer or the principal financial officer of the company (or acted in such capacity) at any time during the taxable year,
    2. Is the among the three highest compensated executive officers for the taxable year (other than an individual described in (1)), or
    3. Was a covered employee of the company or a predecessor at any time after December 31, 2016 (this includes an individual who was a covered employee for 2017 as determined under the pre-amended rules).
    An individual is a covered employee regardless of whether the individual is employed at the end of the taxable year, and regardless of whether disclosure of his or her compensation is required under SEC rules.
  • Grandfathering Rule Interpreted Narrowly. The relief provided by the grandfathering rule is narrow. Specifically, compensation will not be treated as payable pursuant to a “written binding contract,” and as such will not be grandfathered, to the extent that the amount of the compensation can be decreased in the company’s discretion after November 2, 2017. Compensation will also not be grandfathered if the grant of the compensation remained subject to a condition as of November 2, 2017, such as a grant that is subject to board approval. Examples of the narrow relief are provided below.

    As described above, the 2017 amendments provided that compensation payable pursuant to a grandfathered contract becomes subject to the new Section 162(m)deduction limitation rules once the contract is “materially modified.” The new IRS guidance defines a “material modification” to mean an amendment to increase the compensation payable to the employee under the contract. However, the new Suntrust business routing number guidance provides limited exceptions to this rule for reasonable cost of living increases and additional compensation paid on the basis of elements or conditions that are not substantially the same as the elements or conditions that are the basis for grandfathered compensation.

Practical Tips

  • Grandfathering. When applying the grandfathering rule, the first consideration should be whether the covered employee would have been a covered employee for the taxable year if the pre-amended rules had continued to apply.

    We expect the grandfathering rule to have the greatest impact when the covered employee wouldnot have been a covered employee for the taxable year under the pre-amended rules.1 In this case, all compensation under a grandfathered contract (even non-performance based) will remain deductible until the contract is materially modified.

    The grandfathering rule will also apply in the case of a covered employee who would have been a covered employee for the taxable year under the pre-amended rules. However, in this case, grandfathered compensation will remain deductible onlyif such compensation would have qualified as deductible performance-based compensation under the pre-amended rules, and only until the grandfathered contract is materially modified.
  • Negative Discretion. Under the pre-amended rules, many performance-based arrangements provided for shareholder approval of a reach target and allowed the compensation committee to use negative discretion to arrive at a lower actual payout. As described above, Notice 2018-68 provides that performance-based compensation under this type of plan will be grandfathered only to the extent that the compensation was not subject to the company’s negative discretion as of November 2, 2017. For example, if a plan established in early 2017 allowed the company’s compensation committee to apply negative discretion to reduce a payout to a covered employee to $0, then none of the compensation payable pursuant to this mcb will be grandfathered.
  • Recordkeeping. Public companies will now need to implement robust compensation recordkeeping protocols for a greater number of employees. This is because public companies will be required to identify their three highest compensated executive officers (other than their principal executive officer and principal financial officer) in accordance with the SEC’s compensation disclosure framework, even if those persons are not subject to SEC disclosure rules. This includes smaller reporting companies and emerging growth companies, despite the scaled-down SEC compensation disclosure requirements that apply to these companies.
  • Incentive Stock Options. When an employee exercises an incentive stock option, he or she has no ordinary taxable income upon exercise, and if the shares are held for requisite holding periods, the sale proceeds are capital gains. As a result of the 2017 amendments, many public companies may no longer receive a deduction when their executive officers exercise their stock options. Since the company would stand to lose the deduction under Section 162(m) anyway, this may make incentive stock options more attractive.
  • Alternative Forms of Compensation. A grandfathered contract will be considered “materially modified” if it is amended in order to increase the compensation payable under it. However, it is capital one activate a credit card a material modification to provide a covered employee with additional compensation in another form—even if that new compensation is subject to the 162(m) deduction limitation under the new rules—so long as the new compensation is paid on the basis of elements or conditions that are not substantially the same as the elements or conditions for grandfathered compensation.2
  • More to Come Regarding IPO and M&A Considerations. The recent IRS guidance does not address the application of Section 162(m) to corporations immediately after they become public through an initial public offering or a similar business transaction, or to an employee who was a covered employee of a predecessor of the public company.

Fenwick & West will continue to closely monitor any developments and encourages clients to reach out with questions.


1 For instance, a principal financial officer will qualify as a covered employee for all taxable years beginning after January 1, 2018, but generally was excluded from the 162(m)deduction limitation rules in prior tax years. However, we note that in a Chief Counsel Advice (CCA) legal memorandum issued on August 24, 2015, the IRS concluded that a principal financial officer of a smaller reporting company can be a covered employee for a taxable year if he or she is one of the two highest compensated executive officers of the company. The CCA left open the question of whether the same analysis would apply in the case of a principal financial officer of an emerging growth company.

2 For example, assume that an employee who is not a covered employee receives a written binding commitment on August 1, 2017 to receive $500,000 on June 1, 2018. On January 1, 2018, the employee becomes a “covered employee” due to the tax reform. If the company increases the total payout to $800,000, the entire amount will be subject to the 162(m) deduction limitation. However, if the payment remains $500,000, but the company grants new awards of restricted stock worth $300,000, only the new stock awards will be subject to the 162(m) deduction limitation, and the payout under the original contract will remain grandfathered.

Источник: https://www.fenwick.com/insights/publications/new-162m-guidance-irs-notice-2018-68-clarifies-scope-of-tax-reform-and-transition-rules

17.8 Tax deduction limitations related to compensation

The tax deduction that an employer is eligible for under IRC Section 83(h) may be subject to certain limitations. One limitation is the "million-dollar" limitation, established by IRC Section 162(m) (as amended by the Tax Cuts and Jobs Act of 2017), which provides that, for public companies, the annual compensation paid to individual covered employees in excess of $1 million during the taxable year is not tax deductible. All individuals who hold the position of either chief executive officer or chief financial officer at any time during the taxable year are covered employees. Covered employees also include the company's three other most highly-compensated officers, pursuant to the SEC's rules for executive compensation disclosures in the annual proxy statement. Any individual who is deemed a covered employee will continue to be a covered employee for all subsequent taxable years (i.e., they remain a covered person indefinitely).

If annual compensation includes both cash compensation and stock-based-compensation, a company should first assess whether or not a covered employee's compensation will be subject to boone county ky court records Section 162(m) limitation. The anticipated effect of the Section 162(m) limitation should be considered using one of three methods (as discussed below) when recognizing deferred tax assets for awards that may be subject to the limitation. The selection of a method is an accounting policy that should be applied consistently.

We believe that any of the following approaches, if followed consistently, would be acceptable for determining whether a deferred tax asset should be recorded for stock-based compensation that is subject to the IRC Section 162(m) limitation:

  • The impact of future cash compensation takes priority over stock-based-compensation awards. For example, if the anticipated cash compensation is equal to or greater than the total tax-deductible annual compensation amount for the covered employee, an entity would not record a deferred tax asset associated with any stock-based-compensation cost for that individual.
  • The impact of the stock-based compensation takes priority over future cash compensation and a deferred tax asset would be recorded for the stock-based compensation up to the tax deductible amount.
  • Prorate the anticipated benefit of the tax deduction between cash compensation and stock-based compensation and reflect the deferred tax asset for the stock-based-compensation award based on a blended tax rate that considers the anticipated future limitation in the year such temporary difference is expected to reverse.

Example TX 17-3 illustrates accounting for the tax effects of awards that may be subject to the IRC Section 162(m) limitation.

EXAMPLE TX 17-3
IRC section 162(m) limitations

Company USA enters into a three-year employment contract with its CEO, who is a “covered employee” as defined by IRC Section 162(m). The terms of the contract include $1 million of cash compensation to be paid annually. Additionally, 100,000 shares of non-vested restricted stock are granted in year 1 and cliff vest in two years (i.e., the restricted stock will vest and become tax deductible on the first day of year 3). The fair value of the stock on the grant date is $10 per share for a total fair value of $1 million. Assume the fair value of the stock remains constant and the applicable tax rate is 25%.

How would Company USA account for the tax effects of awards that may be subject to the IRC Section 162(m) limitation?

Analysis

As the restricted stock does not vest until Year 3, CEO’s compensation in years 1 and 2 are not subject to the limitation (it does not exceed $1 million). In year 3, the total compensation for tax purposes would be the $1 million cash compensation and the $1 million in restricted stock, which the CEO will be deemed to have received based on vesting. The deferred tax analysis under each of the three methods is as follows:

(1) Cash compensation takes priority – Available tax deductions are first allocated to cash compensation. As the $1 million in cash compensation would fully absorb the Section 162(m) limitation in year 3, the entire $1 million of stock-based compensation would be considered non-deductible. As a result, the stock-based compensation would not give rise to a temporary difference and no DTA should be recognized. The effective tax rate would be higher in years 1 and 2 under this approach as the book stock-based compensation charge would have no associated deduction for tax purposes.

(2) Stock-based compensation takes priority – Available tax deductions are first allocated to stock-based compensation. As the $1 million in stock-based compensation would be large kids piggy bank deductible under the Section 162(m) limitation in year wings financial credit union locations mn, the stock-based compensation recorded for book purposes in Years 1 and 2 ($500,000 per year) would give rise to a temporary difference, and a DTA should be recognized. The cash compensation in year 3 would be considered non-deductible. The effective tax rate would be normal in years 1 and 2 and would increase significantly in year 3 (as a result of the non-deductibility of $1 million in cash compensation).

(3) Pro rata allocation between cash and stock compensation – Available tax deductions would be allocated between cash compensation and stock-based compensation on a pro rata basis. As both cash compensation and stock-based compensation are expected to be $1 million in Year 3 (total 162 m limitation and stock options of $2 million), the available $1 million of tax deductions would be allocated 50:50. Thus, while the stock-based compensation recognized for book purposes in Years 1 and 2 would give rise to a temporary difference, only 50% of the total compensation would be recognized as a deferred tax asset. Therefore, the deferred tax benefit in Year 1 ($500,000 × 50% × 25% = $62,500) and Year 2 ($500,000 × 50% × 25% = $62,500) result in a total DTA at the end of Year 2 of $200,000. The $125,000 DTA would reverse in Year 3 when the stock-based compensation is deducted on the tax return.

Источник: https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/income_taxes/income_taxes__16_US/chapter_17_income_ta_US/178_tax_deduction_li_US.html

Section 162(m) Compliance Alert - Do You Need to Seek Shareholder Approval of Your Incentive Plan in 2014?

Annual Reminder - If the corporation’s equity or annual incentive plan was last approved by shareholders in 2009, the plan(s) must be submitted to shareholders for re-approval in 2014 in order to ensure that future awards qualify as performance-based compensation under Section 162(m).

Compensation paid by a publicly-traded corporation to its CEO and three other highest compensated officers (other than the Principal Financial Officer) is generally not deductible to the extent it exceeds $1,000,000 per year. This limitation, however, does not apply to qualified performance-based compensation that complies with the requirements of Section 162(m).

There are numerous conditions that must be satisfied for awards to be considered performance-based compensation. Recent IRS audit activity in this area continues to reveal a number of common failures, third coast supply (i) making mid-year changes to performance goals; (ii) making adjustments to the performance goals that were not pre-determined (e.g., adjusting for subsequent events); (iii) failing to obtain shareholder re-approval of the plan; (iv) paying awards out upon retirement or an involuntary termination regardless of whether the performance goals were satisfied; (v) using performance measures that are not included in the shareholder approved plan; (vi) paying out the compensation before the compensation committee certifies in writing that the performance goals were obtained; and (vii) issuing stock options in excess of plan limits.

In an effort to assist employers in their compliance efforts, set forth below are a few action items that employer’s should consider in order to enhance compliance.

What Can Employers Do to Enhance Compliance With Section 162(m)?

Shareholder Re-Approval of 2009 Plans: Where a plan allows the compensation committee to establish the performance goals and targets from year to year (as many plans commonly do), Section 162(m) requires that the performance goals be disclosed and re-approved by shareholders every five years. If the corporation’s equity or annual incentive plan was last approved by shareholders in 2009, the plan(s) must be submitted to the shareholders for re-approval in 2014 in order to ensure that future awards qualify as performance-based compensation under Section 162(m).

Review Proxy Disclosures: Plaintiffs’ attorneys continue to bring derivative suits against corporations and their boards challenging the corporation’s compliance with Section 162(m). The lawsuits allege, among other claims, that (i) the corporation failed to comply with the procedural requirements of Section 162(m), and (ii) the corporation’s proxy contained false and misleading statements by failing to disclose that awards violated the terms of the plan and/or did not qualify as performance-based compensation. Corporations should carefully review their proxy disclosures to ensure that they do not suggest or imply that the corporation’s plan and awards will qualify as performance-based compensation under Section 162(m). The use of language such as “may comply” or “is intended to comply” may protect the corporation from allegations of false or misleading statements in the proxy materials. Additionally, disclosures for shareholder approval or re-approval of a plan should be rigorously reviewed to ensure that they are drafted in compliance with the requirements of Section 162(m).

Update/Establish Grant Procedures: Several recent targets of derivative suits contain Section 162(m) claims involving the issuance of equity or incentive awards in excess of the plan’s specified limits. In several cases where the plan’s limits were exceeded, the Company and the executive agreed to rescind the grants that exceeded the limit in order to avoid the costs and distraction of litigation. Therefore, corporations should establish and/or update grant procedures to ensure that awards are made in compliance with the plan’s terms and that award limits are properly monitored.

Appoint a Section 162(m) Compliance Administrator: In light of the technical nature of Section 162(m), corporations should consider designating a compliance administrator in the corporation’s tax or legal department to assume overall responsibility for monitoring compliance with Section 162(m) and the corporation’s established grant procedures. The compliance administrator should be authorized to attend compensation committee meetings, and otherwise be given access to the corporation’s compensation, tax and legal advisors as necessary to carry out his or her responsibilities.

Источник: https://www.bipc.com/

We are pleased to share the following insights from Attorney Michael S. Melbinger, first published January 7, 2020 on the EXECUTIVE COMPENSATION BLOG.

Fair Treatment for CFOs under the New 162(m) Proposed Regulations

Last month year, I blogged on the new Proposed Regulations issued by IRS and the Treasury Department on the changes to Code Section 162(m) made by the Tax Cuts and Jobs Act of 2017 (TCJA). This is a major development for executive compensation professionals, but I stopped blogging when we went into the Holiday Season (and I began to receive a 50% out-of-office bounce-back rate). But the party is over and I will continue by focusing on one aspect of the proposed regs at a time. Today’s topic is the exemption of a certain amount paid to the CFO under the transition/grandfathering rules of Section edmond canada weather, as embellished by the proposed regs. Under the proposed regulations (and in our experience), CFOs are the most likely class of current executives to enjoy grandfathering protection for amounts paid pursuant to a written binding contract in effect on November 2, 2017.

Readers will recall that amounts paid pursuant to a written binding contract in effect on November 2, 2017, may be exempt from the $1 million deductibility limit of 162(m) under certain conditions. For example, certain incentive awards made before November 2, 2017, which satisfied the performance-based compensation requirements of pre-TCJA provision of 162(m) (e.g., stock options and performance shares) could be entitled to grandfathering status and be exempt from the deductibility limit when paid or exercise in subsequent years.

The grandfathering rules for CFOs are even more favorable. Prior to November 2, 2017, a company’s CFO was not a “covered person” under 162(m) and, therefore not subject to the $1 million deductibility limit. Thus, compensation paid or accrued to the CFO pursuant to a grandfathered employment agreement could be exempt, even if the amounts are not performance-based. The proposed regs. provide the following example, which I have edited for brevity:

On October 2, 2017, Corporation executed a 3-year employment agreement with its CFO for an annual salary of $2,000,000 beginning on January 1, 2018. The agreement provides for automatic extensions after the 3-year term for additional 1-year periods, unless the Corporation exercises its option to terminate the agreement within 30 days before the end of the 3-year term or, thereafter, within 30 days before each anniversary date. Termination of the employment agreement does not require the termination of the CFO’s employment with Corporation. Under applicable law, the agreement for annual salary constitutes a written binding contract in effect on November 2, 2017, to pay $2,000,000 of annual salary to the CFO for three years through December 31, 2020. Because the October 2, 2017, employment agreement:

  1. is a written binding contract to pay the CFO an annual salary of $2,000,000, and
  2. the CFO is not a covered employee for the Corporation’s 2018 through 2020 taxable years,

The deduction for the CFO’s annual salary for the 2018 through 2020 taxable years is not subject to section 162(m). However, the employment agreement is treated as renewed on January 1, 2021, unless it is previously terminated, and the $1 million limit will apply to the deduction for any payments made under the employment agreement on or after that date (not grandfathered).

The foregoing example also illustrates the complicated contract renewal and termination issues that apply to agreements that otherwise would be grandfather, but we will save those issues for another day.

Related content:

#executivecomp #executivecompensation #162m #taxcode #TCJA

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Any tax advice contained herein is of a general nature. You should seek specific advice from your tax professional before pursuing any idea contemplated herein.

Securities offered through Lion Street Financial, LLC (LSF) and Valmark Securities, Inc. (VSI), each a member of FINRA and SIPC. Investment miss peregrines home for peculiar children recommendation services offered through CapAcuity, LLC; Lion Street Advisors, LLC (LSF) and Valmark Advisers, Inc. (VAI), each an SEC registered investment advisor. Please refer to your investment advisory agreement and the Form ADV disclosures provided to you for more information. VAI/VSI, LSF and CapAcuity, LLC. are non-affiliated entities and separate entities from OneDigital and Fulcrum Partners.

Unless otherwise noted, VAI/VSI, LSF are not affiliated, associated, authorized, endorsed by, or in any way officially connected with any other company, agency or government agency identified or referenced in this document.

No items found

Related Deferred Compensation and Executive Benefit Topics

Источник: https://www.fulcrumpartnersllc.com/2020/01/13/major-development-for-executive-compensation-professionals/

New Tax Law Affects Exec Comp Deduction, Other Provisions

While the new tax law avoided making major changes to the existing retirement tax provisions, the same cannot be said for the tax treatment of executive compensation and related provisions.

In the event you’ve been avoiding the news for the past two weeks, President Trump signed the Tax Cuts and Jobs Act (TCJA) into law (H.R. 1/P.L. 115-97) on Dec. 22, delivering a nearly $1.5 trillion net tax cut over the 10-year period 2018-2027. The new law affects every segment of the tax code, including corporations, pass-through entities, individual files and estates. However, in order to comply with the budget requirements, the new law includes several revenue raisers to 162 m limitation and stock options offset the cost of the changes, including several compensation and benefit changes.

Following are highlights of the key compensation changes, which include:


  • modifying the deductibility of so-called excessive employee remuneration;

  • extending an excise tax on “excess tax-exempt organization executive compensation";

  • modifying the treatment of qualified equity grants;

  • changing the holding period for so-called carried interest; and

  • increasing the excise tax for stock compensation of insiders in expatriated corporations.


For our previous coverage of the retirement-related provisions and certain other benefits provisions included in the final conference report, click here. In addition, links to some helpful analyses of the key compensation and benefit changes are provided at the end of this post.

Expansion of Code Section 162(m)

One revenue raiser to help offset the cost of the law is a provision to modify the current limitation on so-called “excessive” employee remuneration under Code Section 162(m). Under the provision, the $1 million yearly limit on the deduction for compensation with respect to a “covered employee” of a publicly traded corporation under Section 162(m) is expanded to include the principal executive officer, the principal financial officer and the next three highest paid employees — conforming the definition of “covered employee” with the current SEC reporting rules.

In addition, the current exceptions for commissions and performance-based compensation is repealed, such that the $1 million deduction limit applies to stock options, stock appreciation rights, performance stock units and performance shares. In addition, for a tax year beginning after 2016, once an employee qualifies as a covered employee, the deduction limitation applies to that person so long as the corporation pays remuneration to that person (or to any beneficiaries) – the so-called “once a covered employee, always a covered employee” provision.

The TCJA also extends the Section 162(m) limit to include all domestic publicly traded corporations and all foreign companies publicly traded through American depository receipts (ADRs), or which are otherwise treated as reporting companies under Section 15(d) of the Securities Exchange Act.

The provision applies to tax years beginning after Dec. 31, 2017. The law includes a transition rule specifying that the changes do not apply to any remuneration under a written binding contract in effect on Nov. 2, 2017, and that is not modified in any material respect. For purposes of this rule, any contract that is entered into on or before Nov. 2, 2017, and that is renewed after such date is treated as a new contract entered into on the day the renewal takes effect.

Excise Tax on Tax-Exempt Organization Exec Comp

The TCJA imposes an excise tax of 21% on compensation in excess of $1 million paid to any of the five highest-paid employees of a tax-exempt organization (or any person who was such an employee in any preceding tax year beginning after 2016). The tax applies to the value of all remuneration paid for services, including cash and the cash-value of most benefits.

Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to such remuneration. In addition, the definition of remuneration for this purpose includes amounts required to be included in gross income under Section 457(f). The conference agreement clarifies that substantial risk of forfeiture is based on the definition under section 457(f)(3)(B) which applies to ineligible deferred compensation subject to Section 457(f).

Accordingly, the tax imposed by this provision can apply to the value of remuneration that is vested (and any increases in such value or vested 162 m limitation and stock options under this definition, even if it is not yet received.

The excise tax also applies to excess “parachute payments,” or payments in the nature of compensation suntrust mortgage sign on are contingent on an employee’s separation and, in present value, are at least three times the employee’s base compensation. The base amount would be the average annualized compensation includible in the covered employee’s gross income for the five tax years ending before the date of the employee’s separation from employment.

Parachute payments do not include payments under a qualified retirement plan, a simplified employee pension plan, a simple retirement account, a tax-deferred annuity or an eligible deferred compensation plan of a state or local government employer. The conference agreement also exempts compensation paid to employees who are not highly compensated employees (within the meaning of Section 414(q)) from the definition of parachute payment, and also exempts compensation attributable to medical services of certain qualified medical professionals from the definitions of remuneration and parachute payment.

The provision is effective for tax years beginning after 2017.

Treatment of Qualified Equity Grants

While not a so-called revenue raiser (as described above), the new law includes a provision permitting private companies to allow employees to elect to defer recognition of income attributable to stock received on exercise of an option or settlement of a restricted stock unit (RSU) until an opportunity to sell some of the first financial bank indianapolis locations arises. Qualified employees are permitted to defer recognition for up to five years from the date the employee’s right to the stock becomes substantially vested.

If an employee elects to defer income inclusion under the provision, the income must be included in the employee’s income for the tax year that includes the earliest of:


  • the first date the qualified stock becomes transferable;

  • the date the employee first becomes an excluded employee;

  • the first date on which any stock of the employer becomes readily tradable on an established securities market;

  • the date five years after the first date the employee’s right to the stock becomes substantially vested; or

  • the date on which the employee revokes their inclusion deferral election.


Elections apply only to stock of the employee’s employer and the options or RSUs would have to be granted in connection with the performance of services by the employee. A written plan must provide that at least 80% of the employees of the company would be granted stock options or RSUs with the same rights and privileges. The conference agreement clarifies that the 80% requirement cannot be satisfied in a taxable year by granting a combination of stock options and RSUs, and instead all such employees must either be 162 m limitation and stock options stock options or RSUs for that year.

In addition, certain employees are not permitted to make the election, including:


  • a 1% owner during the current year or any of the 10 preceding calendar years;

  • anyone who is or has been the CEO or CFO;

  • a family member of a 1% owner or a CEO or CFO; or

  • one of the four highest compensated officers in any of the 10 preceding taxable years.


RSUs are not eligible for a Code Section 83(b) election and receipt of qualified stock would not be treated as a nonqualified deferred compensation plan for purposes of Section 409A (the exception applies solely with respect to an employee who may receive qualified stock).

The provision applies to stock attributable to options exercised, or RSUs settled, after 2017, subject to a transition rule.

Carried Interest

The TCJA includes a provision stipulating that certain partnership interests received in connection with the performance of services are subject to a three-year holding period in order to qualify for long-term capital gain treatment.

Transfers of applicable partnership interests held for less than three years are treated as short-term capital gain. This treatment affects partnership in connection with the performance of substantial services to businesses which consist of engaging in capital market transactions or other specified investments.

The conference agreement clarifies the interaction of Section 83 with the provision’s three-year holding requirement. Under the provision, the fact that an individual may have included an amount in income upon acquisition of the applicable partnership interest or may have made a Section 83(b) election with respect to an applicable partnership interest does not change the three-year holding period requirement for long-term capital gain treatment.

Thus, the provision treats as short-term capital gain taxed at ordinary income rates the amount of the taxpayer’s net long-term capital gain with respect to an applicable partnership interest for the taxable year that exceeds the amount of such gain calculated as if a three-year (not one-year) holding period applies. In making this calculation, the provision takes account of long-term capital losses calculated as if a three-year holding period applies.

The provision applies to tax years beginning after 2017.

Increase Excise Tax for Stock Compensation of Insiders in Expatriated Corporations

Under previous law, certain holders of stock options and other stock-based compensation are subject to an excise tax upon certain transactions that result in an expatriated corporation. An excise tax chase bank call center salary the rate of 15% was imposed on the value of specified stock compensation paid to certain officers, directors and 10% owners of an expatriated corporation.

The TCJA increases the 15% rate of excise tax to 20%, effective for corporations first becoming expatriated corporations after the date of enactment (Dec. 22, 2017).

TCJA Analyses

Descriptions and analyses of the key retirement, compensation and other benefits changes in the new law include:

Источник: https://www.napa-net.org/news-info/daily-news/new-tax-law-affects-exec-comp-deduction-other-provisions

December 22, 2020
2020-2923

Final IRC Section 162(m) regulations have few changes

The IRS published final regulations under IRC Section 162(m) (TD 9932), incorporating Tax Cuts and Jobs Act (TCJA) statutory amendments and making certain other changes to existing rules. The final rules generally follow the proposed rules previously published in December 2019, but there are a few key changes:

  • Additional transition relief for a publicly held corporation's distributive share of the deduction for compensation paid by a partnership on or before December 18, 2020 (common in an "Up-C" or "Up-REIT" structure)
  • A simplified approach for calculating grandfathered amounts of deferred compensation subject to pre-TCJA rules, making it unnecessary to track losses on amounts deferred as of November 2, 2017
  • A different approach to clawbacks, such that the right to recover compensation after it is paid does not affect its grandfathered status
  • Clarification that extending the exercise period for a grandfathered stock option or stock appreciation right is not a material modification and does not cause a loss of grandfathered status

The final regulations also include other, less significant new rules and clarifications.

The final regulations generally apply to tax years beginning on or after the date the regulations are published in the Federal Register, although a taxpayer may choose to apply them to tax years beginning after December 31, 2017, if the taxpayer applies them in their entirety and in a consistent manner. There are special applicability dates for some rules, most of which were included in the proposed regulations.

Background

IRC Section 162(m) imposes a $1 million limit on the deduction that a "publicly held corporation" is allowed for compensation paid with respect to a "covered employee." IRC Section 162(m) was originally enacted as part of the Omnibus Budget Reconciliation Act of 1993 (OBRA 1993), effective for tax years beginning on or after January 1, 1994. Comprehensive final regulations were published in 1995 (1995 Regulations).

As originally enacted, IRC Section 162(m) defined a "covered employee" as the CEO and the next four highest-compensated officers whose compensation was required to be reported to shareholders under the Securities Exchange Act of 1934 (Exchange Act). When the SEC rules were later amended to require disclosure for the CEO, the CFO and the three highest-compensated officers other than the CEO and the CFO, the IRS concluded that there would be only four "covered employees" in most cases: the CEO and the three highest-compensated officers other than the CEO and the CFO.1 For all "covered employees," the 1995 Regulations imposed a "last day" requirement: compensation (such as severance and deferred compensation) paid to an individual who was no longer a covered employee on the last day of the corporation's tax year was not subject to the $1 million deduction limit.

Only publicly held companies that were required to register their common stock under Section 12 of the Exchange Act were subject to IRC Section 162(m) as it was originally enacted. It did not apply to companies that registered debt, voluntarily registered their common stock or were foreign private issuers traded on US exchanges via American Depository Receipts (ADRs). Moreover, IRC Section 162(m) originally contained a significant exception for performance-based compensation, including cash and stock-based compensation contingent upon the attainment of objective performance goals and meeting other requirements, as well as for most stock options and stock appreciation 162 m limitation and stock options TCJA made several amendments to IRC Section 162(m) to expand its applicability, including:

  • Eliminating the exception for performance-based compensation
  • Expanding the definition of "covered employee" to include the CFO, plus any individual who had ever been a covered employee of the publicly held corporation or any predecessor for any tax year beginning after December 31, 2016 (thus, under the TCJA amendments, once an individual is identified as a covered employee, the deduction limitation applies to the compensation paid to that individual even after the individual no longer holds that position or has separated from service)
  • Expanding the definition of "publicly held corporation" to include certain companies to the extent those companies must report under Section 15(d) of the Exchange Act, including foreign private issuers or private companies that have registered debt offerings

All of these amendments were generally effective for tax years beginning after December 31, 2017, but under a grandfather rule any compensation paid pursuant to a written binding contract that was in effect on November 2, 2017, and not materially modified on or after that date, remains subject to IRC Section 162(m) as it existed prior to the TCJA amendments.

In August 2018, the IRS and Treasury released Notice 2018-68 with guidance on a limited number of issues arising under the TCJA amendments. With respect to the definition of "covered employee," the Notice confirmed that the "last day" rule that applied under the 1995 Regulations was eliminated and, therefore, the compensation of a covered employee may be subject to IRC Section 162(m) in some cases even though it is not subject to disclosure under the SEC rules. The Notice also clarified various aspects of the grandfather rule, generally applying analogous transition rules from the 1995 Regulations (see Tax Alert 2018-1679 for a more detailed description of Notice 2018-68).

Rather than amending the 1995 Regulations to reflect the TCJA amendments, the proposed regulations provided a separate, comprehensive set of rules (see Tax Alert 2019-2229). (The 1995 Regulations continue to apply to grandfathered amounts.) The proposed regulations included: (1) rules related to the TCJA amendments (only some of which were contained in Notice 2018-68); (2) new rules completely unrelated to the TCJA amendments; and (3) certain existing rules carried over from the 1995 Regulations. The proposed regulations also included more than 80 examples.

Analysis of the Final Regulations

The following sections of this Alert highlight the key rules and definitions set forth in the proposed regulations that were either retained or modified in the final regulations.

Definition of publicly held corporation

Proposed regulations

Like the 1995 Regulations, the proposed regulations looked to the last day of the corporation's tax year to determine its status as a publicly held corporation. The proposed regulations, however, reflected the TCJA amendments under which a corporation is considered publicly held if any of its securities are required to be registered under Section 12 of the Exchange Act or the corporation is required to file reports under Section 15(d) of the Exchange Act. Under the proposed regulations, a corporation was not considered publicly held while its obligation to file reports under Section 15(d) was suspended. The proposed regulations also clarified that a subsidiary of a publicly held corporation was itself a publicly held corporation and separately subject to IRC Section 162(m) under the affiliated group rules discussed below.

Citing the TCJA amendments and legislative history, the proposed regulations rejected a commenter's suggestion that foreign private issuers be exempt from IRC Section 162(m). The proposed regulations did, however, recognize that a safe harbor for these corporations may be appropriate, given that they are not subject to the SEC executive compensation disclosure rules and thus may incur undue burdens identifying their covered employees.

The proposed regulations generally retained the 1995 Regulations' rules for affiliated groups of corporations. Under those rules, a publicly held corporation included an affiliated group of corporations as defined in IRC Section 1504 (without regard to IRC Section 1504(b)), but each publicly held subsidiary and its subsidiaries (if any) were separately subject to IRC Section 162(m). The proposed regulations included a new rule under which IRC Section 162(m) would apply to a privately held parent corporation with a publicly held subsidiary. The proposed regulations also expanded on the 1995 Regulations' rules for prorating the deduction disallowance among the members of an affiliated group.

The proposed regulations included a new rule for disregarded entities. If a disregarded entity owned by a privately held corporation was an issuer of securities required to be registered under Sections 12(b) or 15(d) of the Exchange Act, the proposed regulations treated the otherwise privately held corporation as a publicly held corporation for purposes of IRC Section 162(m). The proposed regulations included a similar rule for QSubs (certain wholly owned subsidiaries of S corporations).

Final regulations

The final regulations retain the rules from the proposed regulations. Under a new rule, consistent with the proposed rule for QSubs, a real estate investment trust (REIT) that owns a qualified real estate investment trust subsidiary (QRS) is a publicly held corporation if the QRS issues securities required to be registered under Section 12(b) of the Exchange Act or is required to file reports under Section 15(d) of the Exchange Act. There is no safe harbor for identifying covered employees of foreign private issuers in the final regulations because none was proposed by commenters.

The final regulations modify an example involving the application of IRC Section 162(m) in the case of an individual who is a covered employee for only two of the three publicly held corporations in an aggregated group but who is paid compensation by all three. (This was Example 2 in the proposed regulations, but it is Example 20 in the final regulations.) The aggregate compensation paid by the three corporations 162 m limitation and stock options $3 million, and the final regulations conclude that the total deduction disallowance is $1 million, as one might expect. The example in the proposed regulations had concluded that the aggregate deduction disallowance was $1.6 million, which resulted from an allocation method that required double counting of amounts over the $1 million limit. This change was made in response to a comment criticizing the double counting.

Definition of covered employee

Proposed regulations

The proposed regulations generally followed the methodology for identifying covered employees that was set forth in Notice 2018-68. The IRS and Treasury declined to adopt some comments requesting simplification.

Notice 2018-68 did not address how to identify the three most highly-compensated executive officers if the corporation's fiscal year and tax year did not align, such as when the corporation has a full 12-month fiscal year but a short tax year. Under the proposed regulations, the SEC executive compensation disclosure rules would be applied as if the relevant tax year (a short tax year, for example) were the corporation's fiscal year. This rule was proposed to apply to tax years beginning on or after the publication of the proposed regulations in the Federal Register (December 20, 2019).

Notice 2018-68 also did not address how to identify the predecessor of a publicly held corporation for purposes of the rule that treats an individual as a covered employee if the individual was a covered employee of the publicly held corporation or any predecessor corporation for any tax year beginning after December 31, 2016. The proposed regulations supplied rules for a variety of corporate transactions: reorganizations, divisions, stock acquisitions and asset acquisitions. These rules were proposed to apply to corporate transactions for which all events necessary for the transaction occurred on or after the date the final regulations were published in the Federal Register. The proposed regulations also would treat a corporation as its own predecessor if it went from being publicly held to being privately held and then back to being publicly held again within a three-year period (if the corporation became publicly held again on or after the final regulations were published in the Federal Register). For the period prior to publication of the final regulations, the proposed regulations permitted reliance on the proposed rule, or any reasonable, good faith interpretation of the term "predecessor," and defined certain examples of what would not represent a reasonable, good faith interpretation.

The proposed regulations also treated employees of disregarded entities and QSubs as covered employees of their corporate owners if those employees were executive officers of the corporate owners under the SEC rules.

Final regulations

The final regulations retain the rules from the proposed regulations, with certain minor additions and clarifications. The final regulations provide rules for identifying the covered employees of a REIT that owns a QRS. The final regulations also clarify that for purposes of determining the predecessor of a publicly held corporation in the context of an asset acquisition the 80% threshold for operating assets refers to gross operating assets and not net operating assets.

Definition of applicable employee remuneration

Proposed regulations

The proposed regulations provided that "applicable employee remuneration" (referred to in the proposed and final regulations as "compensation" for simplicity) meant: (1) the aggregate amount allowable as a deduction under chapter 1 of the Code for the tax year; (2) determined without regard to IRC Section 162(m); (3) for compensation for services performed by a covered employee; (4) regardless of whether the services were performed during the tax year. The proposed regulations reiterated that compensation includes an amount that is includible in the income of, or paid to, a person other than a covered employee, including after the death of the covered employee.

Among the most significant new rules in the proposed regulations were the rules for partnerships. These rules were unrelated to the TCJA amendments and were not in the 1995 Regulations. The proposed regulations would have applied IRC Section 162(m) to compensation payments made to a covered employee by a partnership to the extent the IRC Section 162 deduction for that compensation was allocated to a publicly held corporation (or its affiliate) based on the corporation's interest in the partnership. This result was contrary insight credit union mobile banking four private letter rulings2 and would effectively subject "Up-REITs" and businesses with so-called "Up-C" partnership structures (in which a publicly held REIT or corporation, as applicable, holds an interest in a lower-tier operating partnership) to IRC Section 162(m) for the first time. This part of the proposed regulations had a special grandfather rule under which IRC Section 162(m) would not apply to compensation paid pursuant to a written binding contract in effect on the date the proposed regulations were published in the Federal Register (December 20, 2019) and not materially modified after that date.

Under the proposed regulations, IRC Section 162(m) would not be limited to compensation paid to a covered employee for services as an employee, but instead would also include compensation for services the individual rendered as an independent contractor. What's more, the preamble to the proposed regulations asserted that this has been the rule since the enactment of IRC Section 162(m) in 1993. To reach that conclusion the IRS and Treasury relied heavily on the OBRA '93 legislative history, which states: "If an individual is a covered employee for a tax year, the deduction limitation applies to all compensation not explicitly excluded from the deduction limitation, regardless of whether the compensation is for services as a covered employee and regardless of when the compensation was earned." House Conf. Rep. 103-213, 585 (1993).

Final regulations

The final regulations retain the rules from the proposed regulations but provide additional transition relief for a publicly held corporation's distributive share of a partnership's compensation deductions. In addition to grandfathering compensation paid pursuant to a written binding contract in effect on December 20, 2019 (and not materially modified after that date), compensation paid on or before December 18, 2020, is not subject to the partnership rule. This date corresponds to the date the final regulations were available on the IRS website, which precedes the Federal Register publication date.

Some practitioners had wondered whether the final rules would be expanded even further to apply IRC Section 162(m) to compensation paid by a partnership's corporate subsidiaries (commonly found in an "Up-REIT" structure where the operating partnership holds a taxable REIT subsidiary). The Preamble, however, affirms that, "[a]ssuming the partnership is respected for U.S. federal income tax purposes, [IRC S]ection 162(m) generally would not apply to compensation paid to a publicly held corporation's covered employee by a corporate subsidiary of a partnership for services performed as an employee of the subsidiary because, in this circumstance, the corporate subsidiary would not be a member of the publicly held corporation's affiliated group."

IPO transition rule

Proposed regulations

The 1995 Regulations provided a transition rule for a corporation that becomes publicly held. While this rule was not limited to initial public offerings (IPOs), it is commonly known as the "IPO transition rule." The Preamble to the proposed regulations explained that the rationale for this rule was tied to the performance-based compensation exception, which the TCJA eliminated. Under the proposed regulations, the IPO transition rule would not apply to corporations that became publicly held corporations on or after the date the proposed regulations were published in the Federal Register (December 20, 2019). Instead, the proposed regulations specified that a privately held corporation that became publicly held would be subject to IRC Section 162(m) for the tax year ending on or after the date that its registration statement became effective under either the Securities Act or the Exchange Act.

Final regulations

The final regulations retain the rules from the proposed regulations and clarify that a subsidiary that was a member of an affiliated group may continue to rely on the transition rule if it became a separate publicly held corporation on or before December 20, 2019.

Grandfathering

Proposed regulations

The proposed regulations retained all the grandfather rules from Notice 2018-68, including some of the same examples.

Notice 2018-68 made clear that compensation was not grandfathered to the extent the corporation was not obligated under applicable law to pay it as of November 2, 2017. Stated differently, compensation with respect to which the corporation retained negative discretion (that is, the legal right not to pay) was not grandfathered.

Notice 2018-68 did not address discretionary clawbacks — compensation that the corporation could require the covered employee to repay only if certain circumstances arise. Under the proposed regulations, otherwise grandfathered payments would not lose their grandfathered status so long as the corporation's right to demand repayment was based on conditions objectively outside the corporation's control and the conditions giving rise to the corporation's right to demand repayment had not occurred. If the conditions did occur, however, then only the amount the corporation was obligated to pay under applicable law (taking into account the occurrence of the condition) would remain grandfathered.

Notice 2018-68 included numerous examples that focused on defined contribution plans. The proposed regulations clarified that the same basic rule applied to both defined contribution plans and defined benefit plans: only the amount of compensation that the corporation was obligated to pay under applicable law on November 2, 2017, was grandfathered. To illustrate the application of this rule, the proposed regulations included new examples involving defined benefit plans and other types of arrangements, such as "linked plans" (nonqualified deferred compensation plans linked to qualified retirement plans) and severance agreements, as well as earnings on grandfathered amounts.

Under the TCJA, an otherwise grandfathered amount loses its grandfathered status if there is a material modification of the written binding contract on or after November 2, 2017. Drawing heavily from the 1995 Regulations, Notice 2018-68 addressed a number of material modification issues. The proposed regulations retained all the rules from Notice 2018-68. One issue Notice 2018-68 did not address, however, was whether acceleration of vesting would be considered a material modification. Under the proposed regulations, the acceleration of vesting was not treated as a material modification.

Notice 2018-68 also did not address how to identify the grandfathered amount when compensation is paid in a series of payments rather than as a lump sum. Under the proposed regulations, the grandfathered amount would be recovered first, and non-grandfathered amounts would be recognized only after the grandfathered amount was fully recovered.

Final Regulations

The final regulations generally retain the rules from the proposed regulations, but those rules are expressed using fewer illustrative examples and more operative rules. In addition, there are four key changes to the proposed rules.

First, the final regulations have a different rule for clawbacks. As the Preamble explains, "After further consideration, the Treasury Department and the IRS recognize that the corporation's right to recover compensation is a contractual right that is separate from the corporation's binding obligation under the contract (as of November 2, 2017) to pay the compensation. Accordingly, these final regulations provide that the corporation's right to recover compensation does not affect the determination of the amount of compensation the corporation has a written binding contract to pay under applicable law as of November 2, 2017, whether or not the corporation exercises its discretion to recover any compensation in the event the condition arises in the future."

Second, the final regulations include a new rule under which the grandfathered amount is not required to be reduced for losses after November 2, 2017. Tracking grandfathered amounts is simpler under this rule because it is unnecessary to distinguish investment gains and losses from new plan benefits if the value of the grandfathered benefit falls after November 2, 2017.

Third, the final regulations require the grandfathered amount to be determined on a plan-by-plan basis. Thus, for example, if a participant's grandfathered benefit under one plan is forfeited, the grandfathered amount does not become available under another plan — the grandfathered amount associated with the forfeited compensation is simply lost.

Finally, the final regulations add a rule that extending the exercise period for a grandfathered stock option or stock appreciation right is not a material modification and does not cause a loss of grandfathering, provided that the extension complies with Home remedies for gout attack. Reg. Section 1.409A-1(b)(5)(v)(C)(1). A common example is an employer allowing a stock option to be exercised for a short time after an employee separates from service, even though the original terms of the stock option called for the exercise period to end upon separation from service.

Applicability dates

Although the final regulations generally apply to tax years beginning on or after the regulations are finalized, there are special applicability dates for certain rules. Where relevant, the special applicability date for each newly proposed rule is identified in the discussion above along with the description of the rule. In addition, the rules contained in Notice 2018-68, nearly all of which were retained in both the proposed and final regulations without substantive changes, apply to tax years beginning on or after September 10, 2018.

The following chart summarizes the final applicability dates:

Rule

Applicability date

Tax year for calendar-year taxpayers

Notice 2018-68 rules for covered employees and grandfathering

Tax years ending on or after September 10, 2018

2018

Identifying three highest compensated executive officers when tax year is different from fiscal year

Tax years ending on or after December 20, 2019

2019

Distributive share of partnership compensation deduction

For compensation paid after December 18, 2020

2020 (for compensation paid December 19-31, 2020 that is not grandfathered)

IPO transition rule repealed

Corporation becomes publicly held after December 20, 2019

Depends on transaction date

Predecessor corporation rules for identifying covered employees

Transactions on or after date of publication in the Federal Register

Depends on transaction date

Public to private to public 36-month cooling off period

Corporation becomes publicly held again on or after date of publication in the Federal Register

Depends on date corporation becomes publicly held again

All other rules

Tax years beginning on or after date of publication in the Federal Register

2021

Implications

Taxpayers likely will be disappointed by the modest changes to the proposed rules. Commenters had suggested numerous changes that would have narrowed the scope of IRC Section 162(m), thereby allowing taxpayers greater compensation deductions. Nearly all those suggestions were rejected.

The most important change in the final regulations is the additional transition relief for a publicly held corporation's distributive share of a partnership's compensation deductions. As proposed, this rule would have applied retroactively once the final regulations were published. The proposed regulations were published in the Federal Register on December 20, 2019, and this rule was proposed to apply to tax years ending on or after that date (2019 in the case of a calendar year taxpayer). This put some taxpayers in an awkward position, because they had to file tax returns without knowing whether this rule would be included in the final 162 m limitation and stock options and applied retroactively as proposed. In many cases, however, this was a moot point, thanks to the special grandfather rule for amounts paid pursuant to a written binding contract in effect on December 20, 2019. Thus, many taxpayers had been expecting 2020 to be the first year the new partnership rule would have any practical effect. The additional transition relief for amounts paid on or commercial property for rent pittsburgh December 18, 2020, likely will allow those taxpayers to avoid applying the partnership rule for one more year. In many cases, this will mean one more year of avoiding the $1 million deduction limit entirely.

Other favorable changes in the final regulations were more modest. These changes include the simplified approach for calculating grandfathered amounts subject to pre-TCJA rules, making it unnecessary to track losses on amounts deferred as of November 2, 2017; the more reasonable approach to clawbacks; and the clarification that extending the exercise period for a grandfathered stock option or stock appreciation right is not a material modification and does not result in a loss of grandfathering.

If there is a silver lining for tax professionals, it is that the final rules are by and large familiar. Indeed, some of the most important rules in the final regulations were carried forward from Notice 2018-68, which was released more than two years ago.

———————————————

———————————————
ENDNOTES

1 Notice 2007-49. With regard to smaller reporting companies (and emerging growth companies), the SEC rules allow for reduced disclosure, generally consisting of three individuals: the CEO and the two highest-compensated officers other than the CEO. The IRS confirmed in CCA 201543003 that the CFO would be considered a "covered employee" subject to IRC Section 162(m) if the CFO's compensation is required to be disclosed as one of the two highest-compensated officers.

2 PLR 200837024, PLR 200727008, PLR 200725014 and PLR 200614002. Since 2010 this has been an issue on which the IRS will not issue rulings, but taxpayers and their advisors have come to their own views based upon the statutory and regulatory rules in effect.

Источник: https://taxnews.ey.com/news/2020-2923-final-irc-section-162m.

Tax reform legislation expanded the one-million-dollar annual deduction limitation applied to certain compensation paid to top executives of publicly held companies. The result? More disallowed compensation deductions for more companies and on more employees, a higher 162 m limitation and stock options statement cost of compensation, and more work to account properly for the new tax effects in financial statements issued under generally accepted accounting principles.

How did tax reform affect the deductibility of, and income tax accounting for, compensation paid to top executives of public companies?

Answer: Previously, Section 162(m) of the Internal Revenue Code imposed a one-million-dollar annual limit on deductible compensation paid to each of up to four top executives employed at year-end by publicly held companies. Commissions and incentive pay meeting certain performance-based criteria could escape limitation. HR 1, commonly known as the Tax Cuts and Jobs Act (TCJA), expanded the application of the one-million-dollar limit to more companies, to more employees, for longer time periods, and to more types of compensation. For financial reporting purposes, to record the correct tax effect on accrued compensation expense, more analysis is needed to determine if that expense will ever be deductible in tax returns. What once were temporary differences that created deferred tax assets now may be permanently nondeductible book-to-tax differences.

Major Changes to Section 162(m)

These changes generally are effective for compensation deductible in tax years beginning after December 31, 2017:

  • Companies. Section 162(m) previously applied to corporations issuing any class of common equity securities required to be registered under Section 12 of the Securities Exchange Act of 1934 (the Exchange Act). Changes made by the TCJA now encompass issuers of any type of publicly traded security, including debt, as well as certain broker dealers and all foreign companies publicly traded through American depository receipts that file U.S. federal tax returns.
  • Employees. Immediately prior to the TCJA, Section 162(m) covered only four employees—the principal executive officer (PEO) at the close of the taxable year and the three most highly compensated officers for the taxable year other than the PEO or the principal financial officer (PFO), all as defined in reference to the Exchange Act. Now, covered employees are those who were the PEO or PFO at any time during the year as well as those whose compensation must be reported in the company’s proxy statement (or would be required how much is it to load a cash app card the company had to file a proxy statement) because they were the three most highly compensated officers other than the PEO or PFO.
  • Time period. Prior to the TCJA, compensation was subject to limitation only if it was deductible in a year in which an individual was a covered employee as of the last day of the tax year. The TCJA takes a “once a covered employee, always a covered employee” approach, extending the limitation to compensation paid to the employee, even after death, if he or she had been a covered employee of the taxpayer (or any predecessor) for any tax year beginning after December 31, 2016. Thus, the opportunity is lost to avoid the limitation by deferring payment of compensation until after an executive retires, and the number of covered executives will grow over time.
  • Types of compensation. The TCJA removed the exception for commission payments and compensation meeting certain performance-based criteria. Now, all compensation will be subject to the one-million-dollar deduction limitation except qualified retirement plan payments and amounts excludable from the recipient’s gross income (such as employer-provided health benefits and miscellaneous fringe benefits). Amounts paid pursuant to a written binding contract in effect on November 2, 2017, and not materially modified on or after that date are not subject to limitation if they would not have been limited prior to the TCJA. Until further guidance is provided, considerable uncertainty exists about exactly what contracts would be grandfathered under this transition clause.

What Tax Accounting Analysis Is Required Under GAAP?

Prior to the TCJA, to record the proper tax effect, companies that paid different types of Section 162(m)-limited compensation to their covered executives had to determine an order of priority in applying the annual one-million-dollar limit to that compensation, particularly if some compensation was expensed for financial statement purposes in years before it potentially would be deductible in tax returns. This commonly occurred when a company granted restricted stock that did not meet the performance-based criteria in addition to paying cash salary. For example, assume a calendar-year company that on December 31, 2015, granted to its PEO a restricted stock award that would vest on December 31, 2017. The grant-date fair value was $1.6 million. The company would expense $800,000 of this amount in 2016 and in 2017. In addition, the company expected to pay and expense $1.2 million of cash salary to the PEO in each of 2016 and 2017. Absent Section 162(m), the company would expect to deduct $1.2 million in 2016 and $2.8 million in 2017 but could red ryder bb gun box only one million dollars each year due to Section 162(m). In practice, companies in this situation would adopt (or have adopted) and apply consistently from year to year one of three accounting policies for determining which items were not deductible:

  1. Cash first. This policy applies the one-million-dollar limit first to cash compensation deductible in each year. Thus $200,000 of the $1.2 million salary expense would be permanently nondeductible in each year. The entire stock award would be permanently nondeductible, since there is no limit left for it to use in 2017. The $800,000 of book expense each year would be treated as permanently nondeductible, instead of as a temporary difference creating a deferred tax asset.
  2. Stock first. This policy applies the limit first to any stock compensation expected to be deductible in the year. Since no stock compensation vests in 2016, that year’s entire limit is applied to the 2016 cash salary, leaving $200,000 of it as permanently nondeductible. The 2017 stock award vest would use the entire 2017 limit before any 2017 cash salary. Thus, the $800,000 expensed in 2016 ultimately would be deductible, and in 2016 it would be treated as a temporary difference creating a deferred tax asset. In 2017, $200,000 of the stock award’s additional $800,000 expense would be deductible, and thus it would be treated as a temporary difference until the vest date, with the remaining $600,000 treated as permanently nondeductible. Alternatively, the company could have taken the approach that 62.5 percent ($1 million of $1.6 million), or $500,000 of each year’s $800,000 stock award expense, was deductible. Either way, the entire 2017 cash salary would be permanently nondeductible.
  3. Pro rata. This policy allocates the one-million-dollar limit between both types of compensation expected to be deductible in a given year. As with the other two approaches, the entire 2016 limit is allocated to the 2016 cash salary, as no stock compensation is scheduled to vest then. The 2017 limit divided by the entire $2.8 million potentially deductible in 2017 ($1.2 million cash salary plus $1.6 million restricted stock vesting) equals 35.7 percent. Thus, 35.7 percent of the 2017 cash salary, and 35.7 percent of the $800,000 stock compensation expense in each of 2016 and 2017, would be treated as deductible.

A company should update its analysis at the end of each period for any changes in expected compensation expense. For example, if the number of restricted shares to vest depended upon meeting certain performance targets (albeit still not qualifying as performance-based for tax purposes), the company would update the amount of total compensation expense for changed expectations regarding target achievement. However, the analysis should always use the per-share grant-date fair value, ignoring any changes in market value that might affect the ultimate deduction amount. Changes to the potential tax deduction caused by market value changes would be dealt with discretely only in the quarter of actual settlement of a stock-based award.

After the TCJA, these same principles should guide accounting for the tax effects of executive compensation, and companies should continue to apply consistently any policies already adopted. However, changes initiated by the TCJA will add considerable complexity to scheduling the expected ultimate resolution of all compensation.

Prior to the TCJA, stock options typically met the performance-based criteria and thus were not a factor in the analysis described here. Now, unless grandfathered into prior treatment, deductibility of the expense of nonqualified stock options (NSOs) must be analyzed for limitation. For example, assume that on January 1, 2018, the PEO was granted non-grandfathered NSOs that had a grant-date fair value of $500,000, vested in two years, and expired on the earlier of January 1, 2030, or thirty days after the PEO terminated employment. The company would expense $250,000 in each of 2018 and 2019 and must determine whether to treat this expense as a temporary deductible difference or as permanently nondeductible, following any of the above policies already adopted. The most challenging aspect may be estimating when the NSOs might be exercised, thus creating the potential deduction event. Companies should consider using the same exercise assumptions employed when computing the fair value of the options at grant date.

Prior to the TCJA, supplemental employee retirement plans (SERPs) and compensation deferred under other nonqualified plans escaped the Section 162(m) limitation, because payouts typically occurred (and were deductible) after the executive was no longer a covered employee. Now, unless grandfathered, these payments will be subject to the limitation. Expected payout schedules will have to be created and analyzed to determine if amounts currently expensed for these plan obligations are temporary deductible differences or permanently nondeductible.

Annual cash bonuses often escaped limitation prior to the TCJA, either because they met the performance-based criteria or the executive deferred the payment to post-employment via a nonqualified plan. Again, unless grandfathered, these payments now will be subject to limitation. If a company’s bonus plan does not meet the criteria for deduction in the year of accrual (but does in the following year when paid), companies should follow a consistent policy for ordering the use of the one-million-dollar limit between current-year cash salary and prior-year bonus paid and deductible in the current year.

How Might the New Rules Change Executive Compensation Plans and Behaviors?

Lost tax deductions are unlikely to drive companies to pay their top executives less, given the competition to attract and retain top talent and the lower value of any tax deduction at the new twenty-one-percent corporate tax rate. However, the new rules might spur other behavioral changes. For example:

  • Companies will have more flexibility in setting the criteria to use for performance-based compensation, because staying within the parameters for deductibility is no longer relevant. One item in particular, a company’s discretion to increase an award, precluded qualification for the pre-TCJA Section 162(m) performance-based exception. This feature now might appear more often.
  • The mix of base versus incentive pay might change, because performance criteria no longer drive deductibility.
  • Executives who previously agreed to defer portions of their compensation to nonqualified plans so the company could retain a deduction might see future deferrals as no longer necessary. Alternatively, pressure might increase to defer but elect payout over time versus taking a lump sum payment upon termination, thereby increasing the number of one-million-dollar annual limitations to support deductibility.
  • Companies might be reluctant to modify older plans so as to save grandfathered deductions of future compensation payments.

If and how companies will revise compensation packages remains to be seen. It likely will take time for tax professionals to refine the new tax accounting analysis necessitated by the TCJA’s changes to Section 162(m), especially in light of the uncertainty noted earlier about applying the grandfathering provision to existing compensation arrangements. One thing is certain, however: there is increased cost, in terms of time and tax dollars, for paying executives the big bucks.


Sheryl VanderBaan, CPA, is a tax partner at Crowe LLP, one of the largest public accounting, consulting, and technology firms in the United States. Julie Collins, CPA, is a senior manager in the Crowe assurance professional practice

Источник: https://taxexecutive.org/the-tax-and-other-costs-of-paying-executives-the-big-bucks/

5 Replies to “162 m limitation and stock options”

  1. シムカ they do at the moment, but I think in the near future banks could work with Apple directly and eliminate MasterCard/Visa. The companies who manufacture the cards (e.g. Gemalto) could also face challenges soon

Leave a Reply

Your email address will not be published. Required fields are marked *