Internal Revenue Code Section 162(m): Proposed Regulations

On January 14, 2025, the Internal Revenue Service and the US Treasury Department issued proposed regulations under Section 162(m) of the Internal Revenue Code (Code) to implement changes under the American Rescue Plan Act of 2021.

Background

Code Section 162(m) prohibits publicly traded companies from deducting compensation paid to covered employees if that compensation exceeds $1 million in a taxable year.¹

Historically, a covered employee included the company’s principal executive officer (PEO) and principal financial officer (PFO) and the three highest-compensated executive officers other than the PEO or PFO (original covered employees), as well as any employee who had qualified as an original covered employee since January 1, 2017.

In 2021, however, Code Section 162(m) was amended to broaden the definition of covered employees—effective for taxable years starting after December 31, 2026—to include any employee who is among the five highest-compensated employees for the taxable year other than the PEO or PFO or the three highest-compensated executive officers, regardless of officer-level status (additional covered employees). Notably, for the purpose of assessing compensation deductibility for additional covered employees, these rules apply only for the fiscal year in which an employee qualifies as an additional covered employee. Therefore, an employee could be an additional covered employee for one year but not qualify in any subsequent year.

The new proposed regulations provide clarification on the determination of additional covered employees as described below.

The Proposed Regulations

The new proposed regulations borrow the definition of employee from Section 3401(c) of the Code, which includes a common-law employee and any officer of a company. The regulations also provide that an employee of any member of an affiliated group that includes the publicly traded company may be an additional covered employee.

Further, to determine whether an employee is an additional covered employee, the proposed regulations define compensation as compensation that would but for Section 162(m) be allowable as a deduction. This is a departure from the definition of compensation applicable to the original covered employees, which is defined as the total compensation required to be disclosed in the Summary Compensation Table under Securities and Exchange Commission rules. This means that a separate methodology for calculating compensation under Section 162(m) will be required for additional covered employees.

As for timing of the new rules, the proposed regulations are scheduled to apply to compensation that is otherwise deductible for taxable years beginning after December 31, 2026, or the date of the final regulations, whichever is later.

 

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^[1] This dollar threshold is not indexed or otherwise adjusted for inflation.

 

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