In March 2021, the American Rescue Plan Act of 2021 (ARPA) amended Section 162(m) of the Internal Revenue Code (the "Code") to expand the covered employees subject to its compensation deduction limitation. Pursuant to the amendment, five additional employees will be covered each year, and such employees need not be executive officers of the company. The ARPA amendment indicated it would be effective for tax years beginning after December 31, 2026, giving companies approximately five years to prepare for the change.1 However, the House Ways & Means Committee's recent proposal would accelerate the effectiveness of the ARPA amendment to tax years beginning after December 31, 2021. If this provision makes it into the final legislation, employers would need to be ready to implement it in just a few months.

Currently, Section 162(m) of the Code restricts publicly held companies from deducting more than $1 million in annual compensation for certain covered employees. A "covered employee" includes the CEO (principal executive officer), CFO (principal financial officer) and the three next most highly compensated executive officers. Once a person becomes a covered employee under Section 162(m), that person remains a covered employee of that employer for all future tax years. The ARPA amendment, as potentially accelerated by the House Ways & Means proposal, would subject to Section 162(m) each year the five next most highly compensated employees of the issuer determined based on total compensation as calculated for purposes of the summary compensation table for the applicable year2 (other than those individuals already covered), irrespective of whether such a person is an executive officer. These additional five employees are not indefinitely covered and would only be covered in the years they are among the five most highly compensated additional employees.

In addition to accelerating the expanded "covered employee" definition passed under the ARPA, the proposal also seeks clarifying changes to Section 162(m). Under the proposal, the term "applicable employee remuneration" would expressly include performance-based compensation, commissions, post-termination compensation and beneficiary payments, thus clarifying the type of compensation that counts toward the $1 million compensation limit on deductibility. The proposal also would clarify that "applicable employee remuneration" includes compensation for services to a publicly held company even if not directly paid by such company. Finally, the proposal seeks to apply the Section 414 aggregation rules (currently applicable to "covered health insurance providers" under Section 162(m)3) to all entities subject to Section 162(m), such that compensation paid for by different members of a controlled group would be aggregated for purposes of determining whether and to what extent a covered employee exceeds the limit on deductible compensation. The proposal authorizes the IRS to issue regulations implementing the aggregation rule, including regulations to prevent avoidance of the deduction limitation (i.e., classifying individuals as other than an employee or compensating individuals through a pass through or other entity).

The proposal is in the process of being marked up and a final version would need to pass both houses of Congress. If passed as currently drafted, the proposal would bring sweeping changes to Section 162(m) in the next corporate tax year. Of note, issuers would need to calculate total compensation for non-executive employees for whom such calculations were not previously prepared and, in many cases, tracked in such a manner. We will continue to follow any changes to the proposal, and provide updates summarizing its expected impact.


1 See our previous client publication titled "162(m) Covered Employee List to Grow."

2 Companies will need to consider the administrative implications of determining their covered employee group for each year. This may pose difficulties for companies with large amounts of variable compensation.

3 I.R.C. Section 162(m)(6)(C)(ii).

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