United States: IRS Issues Guidance On The Applicability Of Section 162(m) To CFO Compensation

Summary: The IRS recently informally revised its guidance regarding which officers of public companies must be considered when determining the compensation deduction limitation of Section 162(m) of the Internal Revenue Code and applied the limitation to CFOs of certain smaller public companies. Since the release of IRS Notice 2007-49, practitioners have understood that the deduction limitation applies only to compensation paid to a public company's CEO and its three most highly compensated individuals (other than the CEO or CFO) and that, by a quirk of cross-referencing between the Code and the Securities and Exchange Commission's (SEC) compensation disclosure rules, Section 162(m) does not apply to compensation paid to the company's CFO, irrespective of the SEC reporting regime applicable to the public company. However, in a Chief Counsel Advice (CCA) legal memorandum issued on August 24, 2015 (and made publicly available in late October), the IRS concluded that the compensation paid to the principal financial officer of a "smaller reporting company" can, in certain circumstances, be subject to the deduction limitation of Section 162(m).

Background: Section 162(m) of the Code generally disallows the deduction of compensation paid by a public company to a "covered employee" in any one taxable year to the extent it exceeds $1 million. The definition of "covered employee" was drafted to track the definition of a "named executive officer" in Item 402 of SEC Regulation S-K as in effect when Section 162(m) was enacted in 1993. Therefore a "covered employee" was defined as (1) the person who is the CEO (or an individual acting in the capacity of the CEO) as of the close of the taxable year and (2) the four other most highly compensated executives whose total compensation for the taxable year is required to be reported to shareholders under the Securities Exchange Act of 1934. Regulations under Section 162(m) make clear that whether someone is a "covered employee" is determined pursuant to the rules under the Exchange Act.

However, in 2006, the SEC amended Item 402 and, in doing so, changed the definition of "named executive officer." Rather than requiring disclosure of the CEO's compensation by virtue of his or her position and of the compensation of four other individuals by virtue of their compensation, the amended rules require disclosure of the compensation of both the principal executive officer and the principal financial officer by virtue of their positions and of the three most highly compensated executives (other than the principal executive officer and the principal financial officer) by virtue of their compensation. In response to the amendments the IRS issued Notice 2007-49 in which it concluded that the definition of "covered employee" would no longer include a public company's principal financial officer (leaving the covered employees to be the CEO and the three other most highly compensated employees (other than the CFO)). Only an act of Congress to amend Code Section 162(m) can restore alignment between the definition of "covered employee" and the definition of "named executive officer" in Item 402.

New Guidance and Open Questions: The CCA revisits the definition of "covered employee" in light of the scaled-back disclosure rules for "smaller reporting companies" adopted by the SEC in 2008. Under the rules applicable to smaller reporting companies, a "named executive officer" includes the principal executive officer by virtue of his or her position, and the company's two other most highly compensated executive officers by virtue of their compensation. The rules do not require disclosure of compensation of an officer by reason of his or her position as the principal financial officer and are, effectively, a narrower version of the pre-2006 definition of "named executive officer" described above. Therefore, in the CCA, the IRS concluded that where a principal financial officer is one of the two most highly compensated executive officers of a smaller reporting company, he or she will be a covered employee under Section 162(m).

The CCA leaves open several questions, including (1) whether a smaller reporting company need only be eligible to rely on the scaled-back disclosure rules or whether it must actually rely on them, in order for Section 162(m) to apply to compensation paid to the company's principal financial officer; (2) whether compensation paid to the principal financial officers of emerging growth companies, which are also eligible to rely on the same scaled-back disclosure rules, will also be subject to Section 162(m); and (3) how the IRS will treat deductions already claimed for compensation paid in excess of the $1 million limitation to CFOs of smaller reporting companies or emerging growth companies since 2008. 

Going Forward: A CCA is not precedential authority. Nevertheless a smaller reporting company, or emerging growth company for that matter, should now consider carefully whether or not compensation paid to its CFO after the end of its applicable Section 162(m) transition period (including as a result of RSUs that were granted during the transition period but that vest following the expiration of the transition period, as described in our previous client alert) will be subject to Section 162(m). (Timing is paramount here. Because the status of "covered employee" is determined in the year in which compensation is deductible, not when, for example, multi-year awards are granted, a CFO could be a covered employee at the date of grant because the company is a smaller reporting company, and yet not be a covered employee when the compensation attributable to the award is deducted in a later year.) Care should also be taken in drafting Section 162(m) disclosure, if any, included in the company's annual proxy statement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Ciara R. M. Baker
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.