The Advisors' Blog

As we reminded readers in December, the 2021 American Rescue Plan Act amended the definition of “covered employees” under Section 162(m) of the Internal Revenue Code — currently limited to a company’s named executive officers — to add a public company’s five highest compensated employees (even if they are not executive officers) for tax years beginning January 1, 2027 and thereafter. Earlier this month, the IRS and the Treasury Department issued proposed regulations to implement the change. This Gibson Dunn alert describes the proposal as follows:

The proposed regulations clarify a few points in determining who qualifies as one of the next five highest compensated employees who make up these additional “covered employees.” Specifically, companies will need to consider all of their common law employees and officers, as well as employees and officers of any member of the company’s affiliated group. Employees for this purpose also include employees of related management entities or professional employer organizations who perform substantially all of their services during the taxable year for the publicly held corporation or members of its affiliated group . . . These additional highly compensated employees may change from year to year and will not remain “covered employees” in perpetuity.

In ranking employees to determine who is the most highly compensated, companies must look at compensation that would be deductible in that tax year but for the application of Section 162(m). As a result, compensation that may be granted in 2025 or 2026 but that is includible in income and deductible by the company in 2027 will be counted forpurposes of determining who is an additional “covered employee” for the 2027 tax year. This may have an immediate impact on companies’ annual compensation planning and how they account for tax for financial statement purposes.

The five highest compensated employees for a given taxable year may include individuals who were already among the company’s covered employees by virtue of previously being a named executive officer for a prior taxable year.

FW Cook argues that the proposed rules’ coverage of employees of other organizations who perform substantially all of their services for the public company during the taxable year is overbroad and potentially pulls in situations that the rule is presumably not intended to capture. For example, the memo suggests that the rule could capture outside counsel or outside consultants working on a large litigation or project or even, for the entertainment industry, an actor in a year a movie is being filmed. The comment period runs until March 17, 2025, and FW Cook urges potentially impacted companies to submit comments.

We’re posting memos like these in our “Section 162(m) Compliance” Practice Area.

– Meredith Ervine