Let's recap so that we can all be on the same page. Prior to the Tax Cut and Jobs Act (TCJA), and oversimplifying somewhat, public companies were entitled to deductions for executive compensation so long as such compensation did not exceed $1 million per year for a covered employee. Performance-based compensation was not to be counted against that limit and covered employees were the CEO plus the four other highest compensated employees.
Since the passage of the TCJA, there have been several key changes to Section 162(m):
- Once you become a covered employee of a company (beginning in 2017), you remain a covered employee of that company, essentially forever;
- The CEO plus four other highest paid has been changed to CEO plus CFO plus three other highest paid;
- Companies no longer get an exemption for performance-based compensation; and
- Some grandfathering exists for certain agreements that existed in writing.
That does not leave a whole lot of wiggle room for companies. And, for companies that have provided large amounts of performance-based compensation to their executive group, meaningful deductions may be gone.
I'm not about to suggest that I can fix this new problem. But, you should note that amounts that have been deductible under Section 404 are unaffected by these changes. Section 404 of the Internal Revenue Code relates to qualified pension plans. What this means is that to the extent that parts of an executive's compensation which would be subject to Section 162(m) are somehow moved into a qualified pension plan, the funding of that plan will, subject to the rules of Section 404, generally qualify for a corporate tax deduction.
Of course, there are a myriad of rules around what it takes to keep such a pension qualified including the nondiscrimination rules of Section 401(a)(4). But, for most companies that still maintain ongoing pensions, the ability to transfer some otherwise nondeductible compensation to such a pension plan may still exist. It's one of the tools in the tool box that companies should look into.