Yesterday afternoon, IRS released Proposed Regulations on the changes to Code Section 162(m) made by the Tax Cuts and Jobs Act of 2017 (to be published in the Federal Register on December 20). The proposed regs follow up on Notice 2018-68, by which IRS provided guidance on these issues last summer. As we feared, but expected, it is mostly bad news. That is, the proposed regs confirm most of the unfavorable interpretations of Notice 2018-68. However, there are a few small bits of good news in the 129 pages of dense reading.
- For compensation received pursuant to the substantial vesting of restricted property or the exercise of a stock option or stock appreciation right that does not provide for a deferral of compensation (under 409A), a modification of a written binding contract in effect on November 2, 2017, which results in a lapse of a substantial risk of forfeiture is not considered a material modification. With respect to other compensation arrangements, if an amount of compensation payable under a written binding contract in effect on November 2, 2017, is subject to a substantial risk of forfeiture (as defined in 409A), then a modification of the contract that results in a lapse of the substantial risk of forfeiture is not considered a material modification. Thus, for all forms of compensation, a modification to a written binding contract that accelerates vesting will not be considered a material modification.
- Earnings on grandfathered amounts, credited after November 2, 2017, are grandfathered if the corporation is obligated to pay the earnings under applicable law pursuant to a written binding contract in effect on November 2, 2017. For example, if a corporation is obligated to continue to credit earnings for amounts in a NQDC plan during a 12 month period after terminating the plan, then the earnings would be grandfathered.
- Severance payable under a contract in effect on November 2, 2017, is grandfathered if the amount of severance is based on compensation elements the employer is obligated to pay under the contract. For example, if the amount of severance is based on final base salary, the severance is grandfathered if the corporation is obligated to pay both the base salary and the severance under applicable law pursuant to a written binding contract in effect on November 2, 2017. For this purpose, a corporation may be obligated to pay severance under a written binding contract as of November 2, 2017, even if the employee remains employed as of November 2, 2017, but only with respect to the amount the corporation would have been required to pay if the employee had been terminated as of November 2, 2017.
- Each component of a severance formula under a written binding contract in effect on November 2, 2017, is analyzed separately to determine the amount of severance that is grandfathered.
- If amounts are paid to an employee from more than one written binding contract (or if a single written document consists of several written binding contracts), then a material modification of one written binding contract does not automatically result in a material modification of the other contracts unless the material modification affects the amounts payable under those contracts.
- When a compensation arrangement purports to provide the corporation with a wider scope of negative discretion than applicable law permits the corporation to exercise, the negative discretion is taken into account only to the extent the corporation may exercise the negative discretion under applicable law
- A corporation is not treated as currently having discretion merely because it will have discretion to recover an amount if a condition occurs subsequent to the vesting and payment of the compensation and the occurrence of the condition is objectively outside of the corporation’s control (e.g., forfeiture due to a criminal fraud conviction).
Among the many items of bad news are confirmations of the positions in 2018-68 that:
- A covered employee for any taxable year means any employee who is among the three highest compensated executive officers for the taxable year, regardless of whether the executive officer is serving at the end of the publicly held corporation’s taxable year, and regardless of whether the executive officer’s compensation is subject to disclosure for the last completed fiscal year under the applicable SEC rules.
- Confirmation that, if after separation from service as an employee, a covered employee returns to provide services to the publicly held corporation in any capacity, including as a common law employee, a director, or an independent contractor, then any deduction for compensation paid to the covered employee is subject to the deductibility cap of Section 162(m).
- Non-deductible compensation may include amount paid to a beneficiary on behalf of a decease former covered employee.
-Mike Melbinger, CompensationStandards.com December 17, 2019