Maximizing Deductions in Light of the Section 162(m) Guidance - - PowerPoint PPT Presentation
Maximizing Deductions in Light of the Section 162(m) Guidance September 6, 2018 Todays Webinar Presenters Mike Melbinger Nyron Persaud Ruth Wimer Employee Benefits and Employee Benefits and Employee Benefits and Executive Compensation
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Mike Melbinger
Employee Benefits and Executive Compensation Chicago mmelbinger@winston.com
Nyron Persaud
Employee Benefits and Executive Compensation New York npersaud@winston.com
Ruth Wimer
Employee Benefits and Executive Compensation Washington, DC rwimer@winston.com
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from Section 162(m) (as well as the lesser utilized commission-based compensation exception).
compensation to any corporation that files SEC reports.
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3. Section 162(m) Now Applies to the CFO. 4. Once a Covered Employee, Always a Covered Employee – Tax Act amends Section 162(m) to provide that any individual who is treated as a “covered employee” under the new rules as described below for any taxable year beginning after December 31, 2016, would continue to be considered a “covered employee” with respect to that company so long as the company continues to provide any remuneration to such individual a)
Previously, Code Section 162(m) only applied to individuals who were named executive officers (other than the CFO) at the end of the year in which the tax deduction was claimed
b)
In 2018 and after, the payment of deferred compensation or an exercise of non-qualified stock options (for example) after an NEO retires (or
deductibility limit
c)
The cap even applies to payment made to a covered employee’s beneficiary after the covered employee’s death
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the circumstances under which certain compensation amounts and payments promised
could be grandfathered and not subject to the compensation deductibility limits of Code Sec.162(m).
statutory provisions. With respect to the grandfather rule, however, the Notice is more restrictive than we had expected. The Treasury Department and IRS anticipate that further guidance on the amendments made by the Tax Act will be issued in the form of proposed regulations which will also incorporate the guidance provided in the Notice. The Notice explains that eventual proposed regulations will follow the Notice for years ending after September 10, 2018, although any rules that are even harsher with respect to the definition of covered employee or written binding contract will apply prospectively only.
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“CFO”)
and CFO), whose total compensation for the taxable year is “required” to be reported to stockholders in the proxy statement under the Securities Exchange Act of 1934
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Old Rule New Rule Any individual serving as CEO or in a similar capacity Any individual serving as CEO or in a similar capacity Any individual whose compensation is required to be reported in the Summary Compensation Table by reason of being among the 4 highest compensated
Any individual serving as CFO or in a similar capacity Notice 2007-49 clarified that CFO is excluded and only 3 highest compensated officers included Among the 3 highest compensated executive officers (other than CEO and CFO)
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New Rule SEC Rule Any individual serving as CEO or in a similar capacity Any individual serving as CEO or in a similar capacity Any individual serving as CFO or in a similar capacity Any individual serving as CFO or in a similar capacity Among the 3 highest compensated executive officers (other than CEO and CFO) Among the 3 highest compensated executive officers (other than CEO and CFO) who were serving as executive
fiscal year Up to 2 additional individuals who would have been among the 3 highest compensated executive officers but for the fact that the individual was not serving as an executive officer at the end of the last completed fiscal year
beneficiary of a deceased covered employee are considered as made to the covered employee and subject to $1 million deduction limitation.
in 2018, and a non-qualified deferred compensation plan account of $5,000,000, payable in equal installments over five years. The former CEO dies in 2022, before exercising any of the vested options and after receiving
the former CEO exercise the vested options for a $1,500,000 gain and the deferred compensation plan distributed $4,000,000 (the deferred compensation plan provides that a participant’s accounts will be paid out in full upon the participant’s death). If the former CEO receives no other payments from the company in 2023, $1,000,000 of the $5,500,000 “payout” made on behalf of the former CEO will be deductible and the remaining $4,500,000 will not be deductible by the company.
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company and Employees B and C both served as the CFO of the company at different times during the year. Employees D, E, and F were, respectively, the first, second, and third most highly compensated executive officers of the company for 2018 (other than the CEO and CFO), but all three retired before the end of 2018. Employees G, H, and I were, respectively, the company’s fourth, fifth, and sixth highest compensated executive officers (other than the CEO and CFO) for 2018, and all three were serving at the end of 2018. In April 2019, the company filed its annual proxy statement and disclosed the compensation of Employee A for serving as the CEO, Employees B and C for serving as the CFO, and Employees G, H, and I pursuant to Item 402(a)(3)(iii) of Regulation S-K. The company also disclosed the compensation of Employees D and E pursuant to Item 402(a)(3)(iv).
are covered employees for 2018.
E, G, H, and I for 2018, the company’s covered employees for 2018 under Sec. 162(m) include Employees D, E, and F, because they are the three highest compensated executive officers
the year.
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with their senior executive officers. Some companies may have entered into change in control agreements or severance agreements instead of or in addition to the employment agreements.
under the TCJA’s transition rule is unexpectedly harsh.
remuneration paid to a covered employee under a written binding contract in effect on November 2, 2017, which is not materially modified after that date.
may not be grandfathered, depending on the particular facts.
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contract law) to pay compensation if the employee performs the requisite services and otherwise satisfies the conditions set forth in the agreement, such that the employee can seek to enforce the payment obligation.
amount stated in the contract. Any payment in excess of the amount the company is legally obligated to pay (other than due to the application of a reasonable interest rate or investment returns), would not be grandfathered.
contract and how long the contract remains in effect, is crucial to the grandfather rule.
their November 2, 2017 compensation arrangements, including both individual agreements and broader based plans, qualify as written binding
state and local law, as well as Federal statutory and common law.
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2017, the employee did not have to be eligible to participate in the arrangement or plan as of that date. However, the covered employee must have been employed by the company, or otherwise had a legally binding right to later participation in the arrangement, as of November 2, 2017.
deferred compensation agreement providing for a payment of $3,000,000 if he continues to provide services through December 31, 2017. In October 2017, however, he terminates employment with that company and executes a new employment agreement with a new company as CFO. The employment agreement provides that, in April 2018, the CFO will participate in the nonqualified deferred compensation plan available to all executives of the company and that his benefit accrued on that date will be $3,000,000. On April 1, 2021, the CFO receives a payment of $4,500,000, which is the entire benefit accrued under the plan.
though he was not eligible to participate in the nonqualified deferred compensation plan on November 2, 2017, he was employed on November 2, 2017 and had the right to participate in the plan under a written binding contract as of that date.
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companies to adjust executive compensation in light of changing circumstances or include unlimited “negative discretion” which taken to the extreme, would allow the company to reduce the payment amount to zero, even when performance and service requirements were met. To the extent that an executive’s compensation is legally binding and enforceable, the grandfather rule may apply to protect the company’s deduction. However, to the extent that compensation is subject to employer discretion, the grandfather rule is far less likely to apply unless such amounts are legally enforceable under state or other applicable law.
which the CEO will receive a cash bonus of $1,500,000 if a specified performance goal is satisfied. The compensation committee retains the right, even if the performance goal is met, to reduce the bonus payment to not less than $400,000 if, in its judgment, other subjective factors warrant a reduction. In 2018, the compensation committee reduces the award to $500,000. In this example, only $400,000 of the $500,000 payment is deductible, but the failure of the compensation committee to exercise negative discretion to reduce the award to $400,000, instead of $500,000, does not result in a material modification of the contract.
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November 2, 2017, is outside the grandfather rule. The Notice makes clear that a renewal can occur actively or passively and covers a range of fact patterns.
an annual salary of $2,000,000, beginning on January 1, 2018, and the terms
additional 1-year periods, unless the corporation exercises its option to terminate the agreement within 30 days before the end of the 3-year (or subsequent) term:
end of the 3-year terms/renewal] would not be subject to the 162(m) deduction limit.
162(m) would apply to any payments made under it on or after that date.
employment relationship with the company.
performance-based compensation because the CFO was not a covered employee under prior law
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contract to fall outside the grandfather rule:
but is no longer covered by the contract.
the duration of the contract, compensation after the contract expires will not be grandfathered, but compensation paid pursuant to the contract could remain grandfathered.
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compensation arrangement. Under the plan, company will pay CFO’s account balance in April 2019, but only if he continues to serve as the CFO through December 31, 2018. Company credits $100,000 to CFO’s account annually for 3 years, beginning on December 31, 2016 (and earnings on the account). Plan provides that company may amend the plan to either stop or reduce the amount of future credits to the account balance. In April 2019, company/Plan pays the CFO $350,000 (including earnings).
account balance on December 31, 2016, because the arrangement would have allowed the company to halt contributions in 2017, prior to crediting of the second $100,000. The remaining $250,000 is subject to the 162(m) deduction limit when distributed in 2019.
the plan as of November 2, 2017, would be grandfathered and $240,000 of the $350,000 payment would subject to the 162(m) deduction limit.
subject to the 162(m) deduction limit because it was paid while he was still employed.
162(m) in the year promised, but for TCJA. That is zero for a CEO (other than performance- based compensation), but unlimited for a CFO.
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amounts paid in 2018 and after could still be deductible if the amounts or awards would have qualified as performance-based compensation under old Sec. 162(m).
annual salary of $1,000,000. Pursuant to the employment agreement, in January 2017, the company grants the CEO non-qualified stock options to purchase 1,000 shares of stock, SARs on 1,000 shares, and 1,000 shares of restricted stock. The restricted stock, options and SARs vest in January 2019. After vesting, the CEO can exercise the options and SARs at any time through January 2027. In January 2021, the CEO exercises the options and SARs.
requirements and would have been deductible but for the elimination of the exception for qualified performance-based compensation by the TCJA, the compensation attributable to the options and the SARs upon their exercise in 2021 will be grandfathered and deductible.
vesting of the restricted stock in 2019.
restricted stock would be granted in January 2018, there would be no written binding contract as of November 2, 2017, and the options and SARS also would have been subject to the 162(m) deduction limit.
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employees under a written binding contract in effect as of November 2, 2017, unless the contract is materially modified after that date.
contract as of the date of the modification.
would remain grandfathered and subject to “old” Sec. 162(m).
material modification will not have occurred where the payment amount is reasonably discounted for the time value of money.
in the payment amount would not be a material modification if it is based on either a reasonable rate of interest or the performance of predetermined investments.
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salary of $1,800,000 per year. In 2018, CFO became a covered employee as a result of the TCJA’s. In 2019, the company increases the CFO’s compensation with a supplemental payment of $40,000. On January 1, 2020, the company increases the CFO’s salary to $2,400,000.
therefore, is grandfathered unless the change in her compensation in either 2019 or 2020 is a material modification.
because the $40,000 payment is less than or equal to a reasonable cost-of-living increase from 2017. The $40,000 supplemental payment is, however, subject to the deduction limitation of Sec. 162(m).
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, and it is greater than a reasonable, annual cost-of-living increase.
compensation paid to CFO in 2020 and thereafter will be subject to the $1 million deduction limit.
have been a material modification of the written binding contract (although the restricted stock grant would be subject deduction limitation).
continued service, not paid on the basis of substantially the same elements and conditions as CFO’s salary.
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(e.g., include PFO)
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3. Work with legal counsel to determine the extent to which each plan and agreement creates a legally binding obligation for the company to pay a specific amount of compensation, including for use by auditors to calculate the Deferred Tax Asset on the company's balance sheet
solely by employee,
4. Determine how long grandfather protection will be available to these amounts
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and after 2017, and retain that information until all payments have been made to any such employee, former employee, or the beneficiaries of a former employee.
review the list to be certain the record is being updated and that its consequences are incorporated into compensation decisions and tax reporting.
TCJA dramatically expanded the universe of employees and former employees who are or can become subject to the deductibility cap and the period of time during-for which they are subject to it.
employee has worked her way up to named executive officer. In 2024, she exercises the options. If the company took care to preserve the grandfather status of the 2016 options, it will be entitled to the entire deduction in 2024, despite the fact that the employee is then a covered employee.
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there are any compensation plans that may have been overlooked) 10.Any fringe benefits or special one-time bonus arrangements, e.g., relocation bonus or reimbursement
plan and/or a supplemental executive retirement plan (SERP).
distribution of a participant’s account balance or accrued benefit usually does not occur until after the participant has terminated
TCJA amendments, distributions would be fully deductible.
plan benefits to a participant who is or ever was a covered employee under 162(m) subject to the $1 million deductibility cap, even if the distribution is made after the participant’s death, disability, retirement or other termination of employment.
non-qualified plan as of November 2, 2017 (and in some cases additional accruals and contributions after that date, could be grandfathered and not subject to the $1 million cap.
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Non-Qualified Deferred Compensation or SERP Plans
new Sec. 162(m). Because distribution of a covered employee’s non-qualified plan benefit of usually occurs after employment termination and can be spread out over a period of time, companies may be able to control the distribution amount in any taxable year, so that, when combined with any
than $1 million and, thus, fully deductible.
the company still will be able to pay and deduct up to $1 million in benefits each year.
employees after retirement or termination will be less than $1 million and, therefore, fully deductible.
payments, cannot be reduced below $1 million, at least the company will be able to postpone the outflow of cash (with no corresponding deduction) for several years
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Automatic Voluntary Deferral of RSUs or Annual Bonus
compensation amounts, such as RSU awards and all or a portion of the incentive bonus. Essentially, the deferred amounts then would become non-qualified deferred compensation and future annual installment payouts could be limited to $1 million per year or less.
compensation programs in the past. Often these companies include
unsecured deferral. For example, in June 2019, a company might offer executives and other employees the choice to receive their 2020 incentive bonus in cash or in deferred RSUs with a fair value equal to 125% of the indicated cash amount.
company’s stock price, particularly in the case of deferred RSUs. The company could place company stock in a rabbi trust to fund the promised deferral.
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Code Sec. 409A
exception to the prohibition on delaying or deferring payments and allow a company to decide to defer the payment of compensation to an executive, without an election in advance, if the compensation is not deductible under Code Sec. 162(m). In each case, however, the deferred payment must be made as soon as reasonably practicable following the first date on which the company anticipates that its deduction with respect to such payment will no longer be limited by the application of Sec. 162(m). The new “once a covered employee, always a covered employee” rule will complicate some companies’ ability to utilize these exceptions, but should not eliminate them.
for the short-term deferral exception, also seems to require an element of surprise on the part of the company. This exception requires that the company establish that “as of the date the legally binding right to the payment arose, a reasonable person would not have anticipated the application of section 162(m) at the time of the payment.”
2017, but not grandfathered.
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promising strategies for mitigating the potential loss of deduction under Sec. 162(m). Additionally, the deferral of executives’ compensation has the salutary effect of enhancing the link between executives’ compensation and their companies’ long-term performance. Therefore, bank regulators (along with institutional investors and proxy advisory firms) should approve of companies’ and executives’ actions to defer equity and cash compensation, particularly if:
stock, and
compensation in particular, was one of the key components of the proposed rules under Dodd-Frank Act Section 956. During the deferral period, compensation would remain subject to a risk of forfeiture, a risk of downward adjustment, and clawback requirements.
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the grandfathered status
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composition to meet the requirements of old Section 162(m)
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Mike Melbinger
Employee Benefits and Executive Compensation Chicago mmelbinger@winston.com
Nyron Persaud
Employee Benefits and Executive Compensation New York npersaud@winston.com
Ruth Wimer
Employee Benefits and Executive Compensation Washington, DC rwimer@winston.com