The NASPP Blog

Remember when I said you should be aware of the new Section 162(m) rules that apply to certain health insurance providers because they indicate the direction Section 162(m) is heading (“CHIPs: More Than a Cheesy TV Show“)? Well, it’s happening. The tax reform package proposed by the House would make some of the same changes to Section 162(m) that already apply to CHIPs.

What Is 162(m) Again?

For those of you who don’t live and breath corporate tax deductions, Section 162(m) limits the tax deduction that companies can take for compensation paid to covered employees (currently the CEO and the top three highest paid executives, not including the CFO—but this is something the proposed legislation would change) to $1 million. A number of types of compensation are exempted from the limit, however, including performance-based pay—this would also be changed by the proposed legislation.

Update to Covered Employee Definition

The proposed tax reform legislation would update the definition of who is a covered employee under Section 162(m) to once again include the CFO. This change has been coming ever since the SEC revised the definition of who is a named executive officer for purposes of the proxy executive compensation disclosures back in 2006. The only thing that is surprising is that it’s taken over ten years for the tax code to catch up (and, actually, it still hasn’t caught up, but it seems pretty likely that this is going to finally happen).

Once a Covered Employee, Always a Covered Employee

The proposed legislation would also amend Section 162(m) to provide that anyone serving as CEO or CFO during the year will be a covered employee (not just whoever is serving in this capacity at the end of the year). Plus, starting in 2017, once employees are covered by the rule, they remain covered employees in any subsequent years that they receive compensation from the company, regardless of their role or amount of compensation they receive. This will prevent companies from being able to take a tax deduction for compensation paid to covered employees simply by delaying the payout until the individuals retire.

This change has been coming for even longer, ever since the SEC updated their definition of named executive officer to include former officers, which happened so long ago I can’t remember when it was (10 points to anyone who can tell me).

Performance-Based Compensation No Longer Exempt

Finally, the proposed legislation would repeal the current exemption for performance-based compensation. This exemption currently applies to both stock options, even if subject to only time-based vesting, and performance awards. Thus, both types of grants would no longer be exempt from the limitation on the company’s tax deduction.

At one time, this might have spelled the curtailment of performance-based awards. But these days, there is so much pressure on companies to tie pay to performance for executives that I don’t see this having much of an impact of pay practices. It does mean that a fairly sizable portion of executive pay will no longer be deductible for many public companies.

Not Final Yet

As I noted in yesterday’s blog, this legislation has a ways to go before it is final. You can rely on the NASPP to keep you in the know, even if it means I have to write blogs on Sunday night. Check out our alert for law firm memos providing more analysis.

– Barbara