The Tax Cuts and Jobs Act (the Act), signed by President Trump on December 22, 2017, included a major overhaul of Section 162(m) of the Internal Revenue Code (Section 162(m)), which will significantly affect executive compensation programs for publicly traded companies going forward.
The key changes are:
Elimination of Exclusion for Performance–Based Compensation: Prior to the Act, Section 162(m) disallowed a corporate tax deduction for compensatory payments to certain executives of publicly traded companies that exceeded $1 million, unless the payments met the requirements for “performance-based compensation.” The Act has removed the exclusion for performance-based compensation. Accordingly, as of January 1, 2018, any payment made to certain executives of publicly traded companies that exceeds $1 million will no longer be deductible, unless the payment is grandfathered under the Act (as discussed below).
Expansion of Covered Employees: Prior to the Act, the limitation on deductibility under Section 162(m) applied to payments made to “covered employees,” which included the company’s chief executive officer and the company’s three next highest paid executive officers as of the close of the year, except the chief financial officer. The Act expands the definition of “covered employees” to include the chief financial officer. In addition, once an employee becomes a covered employee under Section 162(m), he or she will remain a covered employee for future years, even if the individual is no longer the chief executive officer, the chief financial officer or any of the other three highest paid officers for a given year and even after the individual is no longer an employee or an officer of the company. Thus, payments with respect to terminated or deceased covered employees, such as retirement or death benefits under a SERP, may be subject to the deduction limit.
Expansion of Employers: Prior to the Act, Section 162(m) applied to companies required to be registered under Section 12 of the Securities Exchange Act of 1934 (the Exchange Act). Under the Act, Section 162(m) will now apply to companies who are required to file reports under Section 15(d) of the Exchange Act (e.g., companies trading public debt and potentially some foreign issuers).
Grandfathered Arrangements: The Act does provide transition relief to any payment that is payable pursuant to a written binding contract that was in effect as of November 2, 2017 and is not materially modified on or after such date.
Companies subject to Section 162(m) will want to consider:
Reviewing and updating policies and procedures for tracking payments to “covered employees” under Section 162(m), which will include tracking each individual for future years, even after the individual is no longer employed by the company.
Analyzing whether the revisions to 162(m) will cause additional payments under existing programs to become subject to the deduction limitations and the scope of the potential impact.
Reviewing and revising current executive compensation practices and documents in light of the new rules, to either minimize any adverse impact (such as by spreading out payments) or remove plan provisions which are no longer mandatory. Many compensation programs and documents were designed to comply with Section 162(m)’s requirements to satisfy the exclusion for performance-based compensation. For example, equity plan documents often include a list of shareholder approved performance measures and limits on the compensation payable to covered employees. These plan designs and limitations may no longer be necessary. However, companies may want to take a “wait and see” approach to take into account any guidance or feedback from the IRS, the stock exchanges, shareholder advisory firms (such as ISS and Glass-Lewis) and the company’s shareholders.
Updating language in the company’s annual proxy statement regarding the applicability of Section 162(m) and the company’s intentions going forward.
Revising any other documents, such as compensation committee charters and prospectuses for equity plans, that make reference to Section 162(m).
Refraining from any amendments or modifications to current executive compensation arrangements that might jeopardize the grandfathered status of the arrangement.
Calfee’s Employee Benefits and Executive Compensation team will continue to monitor the shifting landscape resulting from this significant change to the tax code. Please feel free to contact us with any comments or questions.