Notice 2018-68, 2018-36 IRB
In a Notice, IRS has provided guidance with respect to changes made by the Tax Cuts and Jobs Act (TCJA; PL 115-97, 12/22/2017) to the rules under Code Sec. 162(m), which limit the deduction for remuneration paid by a publicly held corporation with respect to certain of its executives, i.e., covered employees. Specifically, the Notice discusses the amended definition of covered employees and the operation of a grandfather rule.
Background. Code Sec. 162(m)(1) disallows the deduction by any publicly held corporation for applicable employee remuneration paid to any covered employee to the extent that such remuneration for the tax year exceeds $1,000,000.
The TCJA made several changes to Code Sec. 162(m), including amending the definition of covered employee. The TCJA generally provides that the amendments made to Code Sec. 162(m) apply to tax year beginning after Dec. 31, 2017. However, section 13601(e) of the TCJA further provides that the amendments to Code Sec. 162(m) do not apply to remuneration which is provided pursuant to a written binding contract which was in effect on Nov. 2, 2017 and which was not modified in any material respect on or after such date.
New guidance regarding amended definition of covered employee. The Notice contains the following rules/clarifications regarding the TCJA’s amended definition of covered employee:
…No end-of-year requirement. Code Sec. 162(m)(3)(B) provides that a “covered employee” includes any employee whose total compensation for the tax year is required to be reported to shareholders under the Securities Exchange Act of 1934 by reason of such employee being among the three highest compensated officers for the tax year (other than the principal executive officer (PEO) or principal financial officer (PFO), or an individual acting in such capacity).
Some commenters have asserted that an end-of-year requirement should apply under Code Sec. 162(m)(3)(B) because the Securities and Exchange Commission (SEC) rules relating to executive compensation disclosure under the Securities Exchange Act of 1934 require disclosure of the compensation of the registrant’s three most highly compensated executive officers other than the PEO and the PFO who were serving as executive officers at the end of the last completed fiscal year.
The Notice concludes that there is no end-of-year requirement under Code Sec. 162(m)(3)(B). In reaching that conclusion, IRS noted that: a) the statutory provisions do not impose an end-of-year requirement, and nothing in the legislative history indicates that Congress intended such a requirement to apply; b) the SEC rules require additional disclosure with respect to executive officers that were not serving at the end of the year; c) while certain aspects of Code Sec. 162(m) are interpreted consistent with the SEC rules, the SEC rules do not serve as the sole basis for interpreting Code Sec. 162(m).
…Employees whose compensation is not required to be disclosed under the SEC rules. The flush language at the end of Code Sec. 162(m)(3) provides that the term “covered employee” includes any employee who would be described in Code Sec. 162(m)(3)(B) if the reporting described there were required. In other words, Code Sec. 162(m)(3)(B) applies whether or not SEC reporting is required. Thus, executive officers of publicly held corporations can be covered employees under Code Sec. 162(m)(3)(B) even when disclosure of their compensation is not required under the SEC rules.
…Where corporation’s last completed fiscal year and tax year do not end on the same date. There are circumstances in which a publicly held corporation’s last completed fiscal year and its tax year did not end on the same date – for example, due to a short tax year as a result of a corporate transaction.
IRS requests comments on the application of the SEC executive compensation disclosure rules to determine the three most highly compensated executive officers for a tax year that does not end on the same date as the last completed fiscal year. Until additional guidance is issued, to determine the three most highly compensated employees for purposes of Code Sec. 162(m)(3)(B), taxpayers should base their determination upon a reasonable good faith interpretation of the statute, taking into account the guidance provided under the Notice.
…Persons who were covered employees in previous years. Pursuant to Code Sec. 162(m)(3)(C), the term “covered employee” includes any individual who was a covered employee of the publicly held corporation (or any predecessor) for any tax year beginning after Dec. 31, 2016. For tax years beginning prior to Jan. 1, 2018, “covered employees” are identified pursuant to Code Sec. 162(m)(3) as in effect before the amendments made by the TCJA. Accordingly, covered employees identified for the tax year beginning during 2017 (in accordance with the pre-amendment rules for identifying covered employees) will continue to be covered employees for tax year beginning in 2018 and beyond.
New guidance regarding grandfather rule. Under the TCJA’s Code Sec. 162(m) grandfather rule, the amendments to Code Sec. 162(m) made by the TCJA do not apply to remuneration payable under a written binding contract which was in effect on Nov. 2, 2017 and which is not modified in any material respect on or after such date. The Notice contains the following rules/clarifications regarding the TCJA’s grandfather rule:
…Compensation that exceeds the binding contract amount. Remuneration is payable under a written binding contract that was in effect on Nov. 2, 2017 only to the extent that the corporation is obligated under applicable law (for example, state contract law) to pay the remuneration under such contract if the employee performs services or satisfies the applicable vesting conditions. Accordingly, the amendments to Code Sec. 162(m) made by the TCJA apply to any amount of remuneration that exceeds the amount of remuneration that applicable law obligates the corporation to pay under a written binding contract that was in effect on Nov. 2, 2017 if the employee performs services or satisfies the applicable vesting conditions.
…Employee not eligible for plan as of Nov. 2, 2017. If a compensation plan or arrangement is binding, the amount that is required to be paid as of Nov. 2, 2017 to an employee pursuant to the plan or arrangement will not be subject to the TCJA’s amendments to Code Sec. 162(m) even though the employee was not eligible to participate in the plan or arrangement as of Nov. 2, 2017. However, the TCJA’s amendments to Code Sec. 162(m) will apply to such compensation plan or arrangement unless the employee was employed on Nov. 2, 2017 by the corporation that maintained the plan or arrangement, or the employee had the right to participate in the plan or arrangement under a written binding contract as of that date.
…Renewed contract. the TCJA’s amendments to Code Sec. 162(m) also apply to a written binding contract that is renewed after Nov. 2, 2017. A written binding contract that is terminable or cancelable by the corporation without the employee’s consent after Nov. 2, 2017 is treated as renewed as of the date that any such termination or cancellation, if made, would be effective. Thus, for example, if the terms of a contract provide that it will be automatically renewed or extended as of a certain date unless either the corporation or the employee provides notice of termination of the contract at least 30 days before that date, the contract is treated as renewed as of the date that termination would be effective if that notice were given. Similarly, for example, if the terms of a contract provide that the contract will be terminated or canceled as of a certain date unless either the corporation or the employee elects to renew within 30 days of that date, the contract is treated as renewed by the corporation as of that date (unless the contract is renewed before that date, in which case, it is treated as renewed on that earlier date).
…Modifications to the contract, generally. The TCJA’s amendments to Code Sec. 162(m) will apply to any written binding contract that is materially modified after Nov. 2, 2017. A material modification occurs when the contract is amended to increase the amount of compensation payable to the employee. If a written binding contract is materially modified, it is treated as a new contract entered into as of the date of the material modification. Thus, amounts received by an employee under the contract before a material modification are not affected, but amounts received subsequent to the material modification are treated as paid pursuant to a new contract, rather than as paid pursuant to a written binding contract in effect on Nov. 2, 2017.
…Acceleration/deferral of the payment of compensation. A modification of the contract that accelerates the payment of compensation is a material modification unless the amount of compensation paid is discounted to reasonably reflect the time value of money. If the contract is modified to defer the payment of compensation, any compensation paid or to be paid that is in excess of the amount that was originally payable to the employee under the contract will not be treated as resulting in a material modification if the additional amount is based on either a reasonable rate of interest or a predetermined actual investment (whether or not assets associated with the amount originally owed are actually invested therein) such that the amount payable by the employer at the later date will be based on the actual rate of return on the predetermined actual investment (including any decrease, as well as any increase, in the value of the investment).
…Adoption of a supplemental contract. The adoption of a supplemental contract or agreement that provides for increased compensation, or the payment of additional compensation, is a material modification of a written binding contract if the facts and circumstances demonstrate that the additional compensation is paid on the basis of substantially the same elements or conditions as the compensation that is otherwise paid pursuant to the written binding contract. However, a material modification of a written binding contract does not include a supplemental payment that is equal to or less than a reasonable cost-of-living increase over the payment made in the preceding year under that written binding contract. In addition, the failure, in whole or in part, to exercise negative discretion under a contract does not result in the material modification of that contract.
Request for comments. IRS anticipates issuing further guidance on other aspects of Code Sec. 162(m). It requests comments on: (1) the application of the definition of “publicly held corporation” to foreign private issuers, including the reference to issuers that are required to file reports under section 15(d) of the Securities Exchange Act of 1934, (2) the application of the definition of “covered employee” to an employee who was a covered employee of a predecessor of the publicly held corporation, (3) the application of Code Sec. 162(m) to corporations immediately after they become publicly held either through an initial public offering or a similar business transaction, and (4) the application of the SEC executive compensation disclosure rules for determining the three most highly compensated executive officers for a tax year that does not end on the same date as the last completed fiscal year.
Effective date. IRS anticipates that the guidance in the Notice will be incorporated in future regs that, with respect to the issues addressed in the Notice, will apply to any tax year ending on or after Sept. 10, 2018. Any future guidance, including regs, addressing the issues covered by the Notice in a manner that would broaden the definition of “covered employee” or restrict the application of the definition of “written binding contract” as described above, will apply prospectively only.
References: For the deduction limit for compensation over $1 million paid to top officers, see FTC 2d/FIN ¶ H-3776; United States Tax Reporter ¶ 1624.009.
