On January 16, 2025, the IRS and the Department of the Treasury published proposed regulations relating to Section 162(m) of the Internal Revenue Code.1 The proposed regulations provide guidance on, and implement, the amendments made to the section as part of the American Rescue Plan Act of 2021 (ARPA).2
Section 162(m) generally limits the amount of compensation paid to certain covered employees that a publicly held corporation can deduct for corporate income tax purposes to $1 million per year. For taxable years beginning after December 31, 2017, “covered employees” include officers or former officers, including anyone who (i) served as the principal executive officer (PEO or CEO) or principal financial officer (PFO or CFO) (or in such capacity) at any time during the taxable year, (ii) the next three highest-compensated officers other than the CEO or CFO (regardless of whether such individual was an officer as of the last day of the taxable year), and (iii) anyone who had ever served in such covered employee roles since January 1, 2017 (Current Covered Employees).
For taxable years beginning after December 31, 2026, ARPA expands the definition of covered employees to include the next five highest-compensated employees, even if such employees are not officers (Additional Employees). However, unlike Current Covered Employees, who will remain covered employees for all future taxable years, Additional Employees will be covered employees only for the years in which they are compensated as one of the next five highest-compensated employees within their publicly held corporation.
Key Takeaways
- For purposes of the proposed regulations, “employee” means an employee as defined in Section 3401(c) of the Internal Revenue Code, which generally includes both a common law employee and an officer of a corporation. An “employee” for this purpose would also include an individual who is an employee of a third-party employer other than the publicly held corporation (such as an employee of a related but unaffiliated organization, a professional employer organization or an external manager) but nevertheless functions as an employee of the publicly held corporation as a result of performing substantially all of their work for the publicly held corporation during the taxable year. The “compensation” of the employee for this purpose would be the amount paid by the publicly held corporation to the third-party employer for such work that would otherwise be deductible by the publicly held corporation (such as the service fee paid to a professional employer organization or the management fee paid to an external manager).
- The proposed regulations provide that, for purposes of ranking and identifying the additional five most highly-compensated employees, “compensation” is calculated based on amounts that would, but for Section 162(m), be allowable as a deduction (as opposed to calculating compensation under the SEC disclosure rules pursuant to Item 402 of Regulation S-K for the three highest-compensated officers other than the CEO or CFO). Companies will be required to track such otherwise deductible employee compensation for the additional five covered employees on an employee-by-employee basis.
- The proposed regulations further outline that any employee of any corporation (including a foreign corporation) in the affiliated group of corporations that includes the publicly held corporation may be one of the five highest-compensated employees of the publicly held corporation, regardless of whether the employee is an employee of or performs services for the publicly held corporation.
- An individual (such a former officer) who is already a covered employee by virtue of having served as a covered employee since January 1, 2017, may qualify as one of the next five most highly compensated employees.
Comments and requests for a public hearing regarding the proposed regulations must be submitted by March 16, 2025. Once finalized, the regulations will apply to compensation that is otherwise deductible for taxable years beginning after the later of December 31, 2026, or the date of publication of the final regulations.
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1 REG-118988-22, 90 Fed. Reg. 4691 Certain Employee Remuneration in Excess of $1,000,000 under Internal Revenue Code Section 162(m) (Jan. 16, 2025).
2 See Bloomberg’s April 2021 Tax Management Compensation Planning Journal article “Section 162(m) and the Impact of the American Rescue Plan Act of 2021.”
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