Remind me again, what’s Section 162(m)?

Image by Gerd Altmann from Pixabay

In general, Section 162(m) of the Internal Revenue Code provides that a publicly held corporation shall not be allowed a deduction for any “applicable employee remuneration” to any “covered employee” that exceeds $1,000,000.  Applicable employee remuneration generally means compensation for services performed.  Though the definition has changed over time, “covered employee” originally captured a company’s CEO as of the last day of the taxable year, as well as the next three most highly compensated officers.

Insert the TCJA

The Tax Cuts and Jobs Act of 2017 (the “TCJA”) took the first stab at widening the net used to determine who is a “covered employee.”  Specifically, the definition was expanded to include any person who served as CEO or CFO during the taxable year, in addition to the next three most highly compensated officers.  Additionally, the definition was expanded to include any individual who was a “covered employee” for any taxable year beginning after December 31, 2016.  The TCJA also made other notable changes to Section 162(m), including the elimination of an exception for qualified “performance-based compensation” approved by stockholders.  The practical effect of this was to eliminate the need for stockholder votes to approve plans providing for “performance-based” compensation, because the compensation in question would be non-deductible whether or not it was performance-based.

The Rescue Plan joins the party

On March 11, 2021, President Biden signed the American Rescue Plan Act of 2021 (the “Rescue Plan”).  Nestled in the Rescue Plan’s provision of stimulus checks and COVID-19 relief was the further widening of the “covered employee” net under Section 162(m).  Under the Rescue Plan, for tax years beginning after December 31, 2026, the definition is expanded to include an additional group—the next five most highly compensated employees of the company.  Those five employees are in addition to the CEO, CFO, the next three most highly compensated employees, and any post-December 31, 2006 “covered employees” already captured under the TCJA changes.  Notably, this new group is redetermined on an annual basis, and the “covered employees” in one year do not necessarily have that status the following year.  Additionally, the changes under the Rescue Plan appear to apply to employees and not strictly officers.


While these changes will not be implemented until 2027, companies should consider the following:

  • Unusual compensation arrangements (i.e., change in control bonuses, fluctuating compensation, etc.) may impact the “covered employee” group.
  • Tracking of individuals constituting “covered employees” needs to be reconsidered. The Rescue Plan effectively doubles the number of “covered employees;” thus, existing mechanisms may not be sufficient.
  • Employee morale can suffer if employees believe that compensation decisions are being tied to Section 162(m) as opposed to performance/merit.
  • Exposure to shareholder claims may arise if there’s a perceived failure to consider the tax effects of Section 162(m).

Companies should be aware of the changes to Section 162(m) under the Rescue Plan as well as the final regulations under Section 162(m) issued on December 18, 2020.  Proper planning and evaluation should lead to a smooth transition when the changes under the Rescue Plan take effect.