Public companies that sponsor nonqualified deferred compensation plans that require Internal Revenue Code Section 162(m) payment delays may want to consider whether removing the payment delay provision from a plan is warranted in light of the 2017 Tax Cuts and Jobs Act (TCJA) changes to the definition of a “covered employee.” The December 31, 2020 deadline is approaching to amend plans to remove Section 162(m) payment delays without the change being considered an impermissible acceleration of payment under Internal Revenue Code Section 409A.
Section 162(m) imposes a $1 million deduction limit on remuneration paid to a “covered employee.” The TCJA changed the Section 162(m) rules so that an individual’s status as a “covered employee” will continue after he or she terminates from employment with a public company. Prior to the TCJA change, an individual ceased to be a covered employee for purposes of Section 162(m) when he or she terminated employment. This change to the “covered employee” definition applies to tax years beginning after December 31, 2016. As a result, covered employees identified for a public company’s 2017 tax year (in accordance with the pre-TCJA rules for identifying covered employees) continue to be covered employees for the company’s 2018 tax year and thereafter.
Separately, under the Section 409A regulations, a payment of deferred compensation could be delayed if a company reasonably anticipates that such payment would not be deductible by the company due to the limits of Section 162(m) (this payment delay provision is not required to be reflected in a plan document, but some plan documents automatically require this type of delay). Section 162(m) limits a public company’s deduction for payments of compensation above $1 million when the payment is made to a covered employee (prior to the TCJA, performance-based compensation was not included in determining the $1 million threshold). Now that an individual’s covered employee status continues after termination of employment, a plan that contains a mandatory Section 162(m) deduction delay for payment of Section 409A–compliant deferred compensation could result in an extended delay in payment of the deferred compensation and, depending on the circumstances, could potentially result in the deferred compensation never being paid.
In the preamble to the Section 162(m) proposed regulations issued in December of 2019, the Treasury Department and IRS agreed that companies can amend nonqualified deferred compensation plans prior to December 31, 2020, to remove Section 162(m) payment delay provisions without such removal being considered an impermissible acceleration of payment under Section 409A.
A Section 162(m) payment delay provision may create uncertainty around when payment may actually be made to an executive under a nonqualified deferred compensation plan, which may be reason for a company to remove a payment delay provision. If the Section 162(m) payment delay is triggered, it could be a number of years before the company can deduct the payment.
On the other hand, a company may wish to retain a Section 162(m) payment delay provision in its nonqualified plan in order to help protect the company’s deduction for the payment of deferred compensation under such plan. Additionally, the delay may be beneficial to plan participants because it spreads out their payments over additional years (potentially providing some tax advantages to the recipient).
The decision on whether to keep or remove the Section 162(m) payment delay from the nonqualified plan document must be made by the company and applied uniformly to all participants (i.e., the participants themselves should not determine what happens). The Treasury Department intends to propose updated Section 409A regulations to clarify issues raised by the TCJA changes to Section 162(m), but it is unclear whether such guidance will be provided prior to the December 31, 2020, amendment deadline set forth in the 2019 proposed regulations.
