Preserving the Deduction: Certain 162(m) Action Items Triggered by Notice 2018-68
Time 4 Minute Read
Categories: Tax

The purpose of this post is to highlight certain action items that a publicly-traded company should consider in order to help it preserve compensatory deductions.  The timing of this post is triggered by Notice 2018-68 that was issued by the IRS on August 21, 2018.

General Background

  • Effective January 1, 2018, the Tax Cuts and Jobs Act of 2017 (the “Act”) eliminated the performance-based exception to the $1mm deduction limit under Section 162(m) of the Code and expanded who is subject to the $1mm deduction limitation.  This means that, starting January 1, 2018, performance-based compensation paid by a publicly-traded company to a “covered employee” (as defined in Section 162(m)) will count towards the $1mm deduction limit unless the compensation in question qualifies under the grandfather rules set forth in the Act.
  • At the beginning of this year many publicly-traded companies were scrambling to interpret the Act, its elimination of the performance-based exception to the $1mm deduction limitation under Section 162(m) of the Code, and the impact of such elimination on the company’s deferred tax asset calculation for purposes of its first quarter financial statements.  At that time the practicing tax community had to make certain assessments because IRS guidance under the Act had not been issued.  For example, prior to the Act “negative discretion” was a most common design feature in compensatory arrangements that otherwise were intended to comply with the performance-based exception to the $1mm deduction limit.  After the Act became effective and during the first quarter of this year, a company’s outside auditors would ask the question of whether the presence of negative discretion destroyed the ability of the compensatory award in question to be subject to grandfather treatment under the Act (i.e., the technical question was whether a written binding contract existed under “applicable law” if the Compensation Committee had the ability to use negative discretion to downward adjust the payouts).  At that time many practitioners took the position (on a more likely than not standard) that the presence of negative discretion would not destroy grandfather treatment (i.e., the technical answer was that a written binding contract more likely than not existed under applicable law even though the compensatory award in question had a negative discretion feature).

New Guidance

This changed a couple of days ago when the IRS issued Notice 2018-68 on August 21, 2018.  The Notice sets forth an IRS position that the presence of “negative discretion” in a performance-based program would likely (but not always) destroy application of grandfather treatment.  And since negative discretion was a most common feature in the design of performance-based compensation prior to January 1, 2018, there are likely a number of compensatory programs that will not be subject to grandfathered treatment (i.e., the underlying compensation will count towards the $1mm deduction limitation, resulting in less deductible compensation).

Current Action Items 

Publicly-traded companies that took a position earlier this year that one or more of their compensatory programs are subject to grandfather treatment under the Act should revisit the issue (the goal is to have sufficient time to adjust their tax positions and deferred tax asset reporting in their financial statements for the third quarter, assuming a calendar year company).  Action items to consider include:

  • Review of all compensatory programs and arrangements that the company considered to be subject to grandfather treatment under the Act.  If negative discretion exists in the program, then make a determination on whether a written binding contract under applicable law exists.
  • Review all arrangements with the company’s principal financial officer to determine whether any of his or her compensatory arrangements are subject to grandfather treatment (e.g., employment agreements, separation pay, etc).  The Notice provides guidance in this regard and should be studied in order to help the company preserve compensatory deductions.
  • Consider tracking on a Covered Employee-by-Covered Employee basis (i.e., the term Covered Employee is defined under Section 162(m)) each of their compensatory arrangements.  Then as to each such arrangement, the company should decide whether such arrangement is subject to grandfather treatment under the Act.  Reason is that grandfathered arrangements need to be highlighted and internally tracked by the company in order to preserve the deduction on a going forward basis (i.e., in order to ensure no material modifications are made in the future that could destroy grandfather treatment).

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  • Partner

    Tony’s multi-disciplinary legal practice focuses on executive compensation, ESOPs and employee benefit arrangements (including their related tax, accounting, securities and corporate governance issues) in the United ...


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