In a recently released Chief Counsel Advice memorandum, the Internal Revenue Service ("IRS") informally revised its guidance regarding which officers of "smaller reporting companies" ("SRCs") should be considered "covered employees" when applying the compensation deduction limitation under Section 162(m) of the Internal Revenue Code of 1986, as amended ("Code"). The IRS concluded that the compensation paid to the principal financial officer ("PFO," commonly referred to as a "CFO") of an SRC may be subject to the deduction limitation under Section 162(m) in certain circumstances. The new IRS guidance is contrary to the prior understanding among practitioners that the deduction limitation only applied to a publicly held corporation's principal executive officer ("PEO," commonly referred to as a "CEO") and its three (two, in the case of SRCs) most highly compensated executive officers other than the PEO or the PFO.
Going forward, SRCs should evaluate whether its PFO will be treated as a "covered employee" under Section 162(m). If so, the SRC will be subject to Section 162(m)'s limitation on deducting its PFO's compensation and should evaluate its compensation arrangements and related proxy statement disclosures to determine if changes should be made.
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