January 2, 2020
162(m): Proposal Would Limit Post-IPO & Transaction Deductibility
– Liz Dunshee
As Lynn blogged a few weeks ago, the IRS recently proposed regulations to implement changes to IRC Section 162(m) that are necessary under the 2017 Tax Cuts & Jobs Act. This Ropes & Gray memo takes a closer look at the impact that the proposed regulations would have on deductibility following IPOs, M&A deals, spin-offs, and other transactions (we’re continuing to post memos on the proposed regs in our “Section 162(m) Compliance” Practice Area). Here’s a few takeaways:
1. The Post-IPO Transition Relief for Newly-Public Companies Has Been Eliminated. The existing regulations under Section 162(m) provide a special transition rule for companies that have gone public. Under the transition rule, executive pay pursuant to plans and agreements that pre-date the Company’s initial public offering and that are disclosed to prospective shareholders are exempt from Section 162(m) for a certain period following the initial public offering as long as those arrangements are not materially modified. The proposed regulations preserve the existing rule for companies that went public on or before December 20, 2019, but eliminate it for companies that go public after that date.
2. Predecessor” Rules Will Make More Pay Nondeductible. Section 162(m) applies to any individual who was a covered employee of a publicly held corporation or any predecessor of a publicly held corporation for a preceding taxable year. The proposed regulations take a sweeping approach to determining what it means to be a “predecessor of a publicly held corporation.”
These rules are significant because the TCJA introduced the “once a covered employee, always a covered employee” requirement, which means that if executives of a predecessor company remain employed or otherwise in service or receive transition or exit packages, their compensation may be wholly or partially nondeductible.
3. Go Private Transactions. Many “go private” transactions in which publicly held corporations are acquired by private equity funds or other non-publicly traded acquirers result in a short taxable year for the target that ends on the closing. The proposed regulations make clear that compensation for this short taxable year in which the target was a publicly held corporation would be subject to Section 162(m). The result is that the deductibility associated with often substantial transaction-based pay to executives in such transactions (e.g., option or RSU cash-outs) would now be sharply curtailed or eliminated.