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By: Richard Lieberman, Dykema Gossett PLLC
THE TAX REFORM LEGISLATION ENACTED IN LATE 2017, known as the Tax Cuts and Jobs Act (Pub. L. No. 115-97) (the Tax Act), made relatively few far-reaching and substantive changes in the area of executive compensation and employee benefits. These changes, summarized in this article, primarily focus on (1) the non-deductibility of excessive employee compensation by publicly held corporations under I.R.C. § 162(m), (2) a new tax deferral option for certain qualified equity grants by private corporations, (3) the imposition of a new excise tax on excessive compensation paid by tax-exempt organizations, and (4) a few adjustments to existing taxadvantaged benefits provisions. However, from an executive compensation and employee benefits perspective, what may be most significant about the Tax Act is what was left out. The original legislative proposals introduced in both houses of Congress would have effectively eliminated the continuing use of non-qualified deferred compensation (NQDC) arrangements. Although the implications of the Tax Act are relatively few in the employee benefit and executive compensation area, the changes that were made are significant, albeit for limited audiences. The new rules described below are generally effective for tax years beginning after December 31, 2017.
Section 162(m) provides that no deduction is allowed to a publicly held corporation for compensation paid to certain covered employees in excess of $1 million. Prior to the Tax Act, an exception to the disallowance of a deduction for excessive compensation applied to qualified performancebased compensation or compensation payable on a commission basis. To qualify as performance-based compensation, the corporation had to maneuver through a labyrinth of conditions to ensure that such incentive compensation arrangements were solely conditioned on the achievement of performance criteria established and certified by a duly constituted compensation committee and approved by company shareholders.
Impact of the Tax Act on Section 162(m)
The Tax Act substantially amends Section 162(m) by (1) significantly expanding the definition of covered employee, (2) eliminating the performance-based compensation exception (other than for grandfathered arrangements), and (3) broadening the limitation’s application to corporations required to report under the Securities Exchange Act of 1934 (the Securities Act). Pub. L. No. 115-97, § 13601.
Under Section 13601 of the Tax Act, the universe of potential covered employees has been greatly expanded. Under prior law, the term included the chief executive officer (CEO) of the corporation and the four highest compensated named executive officers for the taxable year, other than the chief financial officer (CFO). (The CFO was excluded because of a technical conflict between the Internal Revenue Code and Securities and Exchange Commission rules. I.R.S. Notice 2007-49, 2007-1 C.B. 1429.)
A covered employee now includes:
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Richard Lieberman is a senior counsel in the Chicago office of Dykema Gossett PLLC and a member of the firm’s Tax Practice Group. With more than 30 years of broad transactional and structuring experience, Mr. Lieberman concentrates his practice on the use of corporations, partnerships, and limited liability companies in domestic and cross-border acquisitions, restructurings, mergers, and financing transactions. He also advises Dykema’s clients on tax issues related to executive compensation arrangements, including designing and advising on the implementation of executive, equity, and deferred compensation programs
For an overview of the rules governing the executive compensation deduction limitation under I.R.C. § 162(m), as amended by the 2017 tax reform legislation, see
> IRC SECTION 162(M): NAVIGATING TAX DEDUCTION LIMITATIONS FOR EXECUTIVE COMPENSATION
RESEARCH PATH: Employee Benefits & Executive Compensation > Employment, Independent Contractor, and Severance Arrangements > Executive Employment Agreements > Practice Notes
For more information on the important legal and tax considerations when developing executive compensation arrangements for tax-exempt organizations, including new excise tax rules enacted under the 2017 tax reform legislation, see
> EXECUTIVE COMPENSATION ARRANGEMENTS FOR TAX-EXEMPT ORGANIZATIONS
For guidance in the drafting and negotiation of executive compensation agreements from the employer’s perspective, see
> UNDERSTANDING, DRAFTING, AND NEGOTIATING EXECUTIVE COMPENSATION AGREEMENTS ON BEHALF OF EMPLOYERS
RESEARCH PATH: Employee Benefits & Executive Compensation > Employment, Independent Contractor, and Severance Arrangements > Executive Benefits and Perquisites > Practice Notes
For assistance in the drafting and negotiation of executive compensation agreements from the executive’s perspective, see
> UNDERSTANDING, DRAFTING, AND NEGOTIATING EXECUTIVE COMPENSATION AGREEMENTS ON BEHALF OF EXECUTIVES
For a discussion on the tax issues associated with grants of equity-based compensation, see
> TAX RISKS OF EQUITY-BASED COMPENSATION
RESEARCH PATH: Employee Benefits & Executive Compensation > Incentive and Equity-Based Compensation > Equity-Based Compensation > Practice Notes
For an analysis of the basic types of equity and equity-based compensation awards, see
> UNDERSTANDING TYPES AND TAXATION OF EQUITY COMPENSATION