On January 16, 2025, the IRS published proposed regulations to implement and provide guidance regarding amendments made to section 162(m) as part of the American Rescue Plan Act of 2021 (ARPA).  These proposed regulations expand the compensation deduction limitation for publicly held corporations under I.R.C. section 162(m), beginning in 2027.

Section 162(m) generally disallows a deduction by any publicly held corporation for compensation of covered employees in excess of $1 million for the taxable year, when such compensation would otherwise be deductible.  Since the Tax Cuts and Jobs Act, “covered employees,” is defined to include (i) individuals who served as the principal executive officer (“PEO”) or principal financial officer (“PFO”) during the tax year, (ii) the three highest-compensated named executive officers other than the PEO and PFO for the tax year, and (iii) officers who were covered employees for any preceding tax year beginning on or after January 1, 2017.

ARPA expanded this definition of covered employees but with a deferred effective date.  For tax years beginning after December 31, 2026, covered employees include any employee, even if that employee is not an officer, who is among the five highest-compensated employees of a publicly held corporation, other than the PEO or PFO and the three highest-compensated executive officers. 

The proposed regulations implement ARPA’s expanded definition of covered employees and provide guidance for determining when a covered employee is one of the five highest-compensated employees for purposes of the limitation.

  • First, the proposed regulations provide that the term “employee,” as used in section 162(m)(3)(C) and defined in section 3401(c), includes, but is not limited to, officers.  Additionally, an employee of a publicly held corporation will also include an individual who is employed by a person other than the publicly held corporation, but who functions as an employee of the corporation.  For example, an individual who performs substantially all of their services during the tax year for the publicly held corporation would be considered an employee of that publicly held corporation, and amounts paid to that individual would be considered compensation for purposes of the deduction limitation.
  • The proposed regulations also provide that employees of any corporation within a publicly held corporation’s affiliated group may be classified as one of the five highest-compensated employees for purposes of the limitation.  This is true regardless of whether the employee is an employee of, or performs services for, the publicly held corporation.  Treasury was concerned that publicly held corporations may employ highly compensated individuals at subsidiaries to avoid the deduction limitation.  Therefore, this change is intended to capture the highest-compensated employees of a publicly held corporation who are employed at a non-publicly held corporation within an affiliated group.
  • Finally, the proposed regulations include guidance for identifying the five most highly-compensated employees, particularly within an affiliated group.  Compensation is calculated based on amounts that would be allowable as a deduction, but for section 162(m).  Publicly held corporations will be required to track such compensation on an employee-by-employee basis to identify and rank the next five highest-compensated employees in a given tax year.  Additionally, if an employee of a publicly held corporation is compensated by more than one corporation within an affiliated group, the compensation paid to that employee by each member of the affiliated group is aggregated.  However, whether an individual is one of the five highest-compensated employees is determined separately for each publicly held corporation within the group, excluding any compensation already taken into account for another publicly held corporation within the group.

Takeaway

The proposed regulations would expand the compensation deduction limitation for covered employees beginning in 2027.  However, publicly held corporations should begin to track employee compensation and consider what steps, if any, would need to be taken to if the regulation were finalized in its proposed form.  Publicly held corporations should pay particular attention to highly-compensated employees of corporations within an affiliated group, individuals who function as employees of the publicly held corporation (but who are employed by a person other than the corporation), and non-officer highly-compensated employees.

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Photo of Christina Danberg Bubel Christina Danberg Bubel

Christina Danberg Bubel is an associate in the firm’s Washington, DC office, where she is a member of the Tax Practice Group. Christina also maintains an active pro bono practice.

Christina earned her J.D. from the Georgetown University Law Center, where she mentored…

Christina Danberg Bubel is an associate in the firm’s Washington, DC office, where she is a member of the Tax Practice Group. Christina also maintains an active pro bono practice.

Christina earned her J.D. from the Georgetown University Law Center, where she mentored law students in legal writing as part of the Law Fellow Program.

Photo of S. Michael Chittenden S. Michael Chittenden

Michael Chittenden practices in the areas of tax and employee benefits with a focus on the Foreign Account Tax Compliance Act (FATCA), information reporting (e.g., Forms 1095, 1096, 1098, 1099, W-2, 1042, and 1042-S) and withholding, payroll taxes, and fringe benefits. Michael advises…

Michael Chittenden practices in the areas of tax and employee benefits with a focus on the Foreign Account Tax Compliance Act (FATCA), information reporting (e.g., Forms 1095, 1096, 1098, 1099, W-2, 1042, and 1042-S) and withholding, payroll taxes, and fringe benefits. Michael advises companies on their obligations under FATCA and assists in the development of comprehensive FATCA and Chapter 3 (nonresident alien reporting and withholding) compliance programs.

Michael advises large employers on their employment tax obligations, including the special FICA and FUTA rules for nonqualified deferred compensation, the successor employer rules, the voluntary correction of employment tax mistakes, and the abatement of late deposit and information reporting penalties. In addition, he has also advised large insurance companies and employers on the Affordable Care Act reporting requirements in Sections 6055 and 6056, and advised clients on the application of section 6050W (Form 1099-K reporting), including its application to third-party payment networks.

Michael counsels clients on mobile workforce issues including state income tax withholding for mobile employees and expatriate and inpatriate taxation and reporting.

Michael is a frequent commentator on information withholding, payroll taxes, and fringe benefits and regularly gives presentations on the compliance burdens for companies.